Australian Mineral

Economics
A Survey of Important Issues

Monograph 24

Edited by

Philip Maxwell
with the assistance of

Pietro Guj

Published by

THE AUSTRALASIAN INSTITUTE OF MINING AND METALLURGY

Level 3, 15 - 31 Pelham Street, Carlton Victoria 3053 Australia
 © The Australasian Institute of Mining and Metallurgy 2006

The Institute is not responsible as a body for the facts and opinions advanced in any of its publications.

ISBN 1 920806 47 4

Desktop published by:

Jenni Stiffe for The Australasian Institute of Mining and Metallurgy

Compiled on CD ROM by:

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 Preface
The minerals and energy sector plays a major role in the Australian economy. It is surprising, therefore
that there has been no significant Australian monograph in the field of mineral economics since the
mid-1980s. Prior to that time Don Barnett’s Mineral and Energy in Australia was published in 1979 and
two volumes of edited readings appeared in 1984. These were The Minerals Sector and the Australian
Economy edited by Cook and Porter, and Peter Lloyd’s Mineral Economics in Australia.

In endeavouring to fill a perceived gap in the literature, we responded positively to a request from our
colleague, Peter Lilly in late 2003, to consider compiling such a study on behalf of The Australasian
Institute of Mining and Metallurgy.

The field of mineral economics owes its origins in part to engineering economics, a course taught for
more than half a century in many engineering schools around the world. Engineering economics
combines traditional economic analysis applied to the resources sector with associated fields such as
project evaluation, risk analysis and management. Since this is a volume aimed broadly at mineral
sector professionals, our approach has been, at least in part, to embrace this approach.

We have drawn inspiration from other places as well. The AIME volume, The Economics of the
Mineral Industries, which appeared in four editions, is an interesting model. Additionally, the published
notes of Brian Mackenzie, who delivered an annual short course in mineral economics for WMC
Resources and the Australian Mineral Foundation for more than two decades, offers many further
useful insights.

Perhaps the greatest influence, however, has been the experience of offering our own coursework
Master’s program in Mineral Economics at the Western Australian School of Mines (Curtin University
of Technology) since 1993. The opportunity to interact with mining executives and professionals for
more than a decade has shaped the approach for this volume.

After the initial introductory chapter, the remainder of the volume is divided into four main sections.
They are:

• Minerals and the World Economy;

• Minerals — Consumption, Production and Markets;
• Mineral Finance and Investment; and
• Minerals and Public Policy.

The first, second and fourth sections have a distinct economics flavour, while the third section focuses
on financial analysis, project evaluation and risk analysis.

The material in the 18 chapters of this volume reflects in major part the contributions of our Mineral
Economics program’s resident staff. Pietro Guj has played the major role in authoring and coordinating
the finance section, while Philip Maxwell has played this role in the three economics sections.

Yet several other authors have also contributed, five of whom have lectured on the Master’s program as
visiting faculty. They are Phillip Crowson, Rod Eggert, Frank Harman, Peter Howie and Gavin Jahn.
Rick West has also contributed a chapter to the volume.
We would like to express our gratitude to The AusIMM for supporting this project. Don Larkin, Jenni
Stiffe, Brigette Hall, Angie Spry, Kristy Pocock and Jenny Hall deserve particular thanks.

Completing this project has been possible as a result of a twice-interrupted period of academic study
leave for Philip Maxwell from Curtin University. During a six-month leave period, he made visits to
Deakin University in Geelong and to Edith Cowan University at Joondalup. Bruce Clayton, Bill
Dimovski and Carol Adams at Deakin, as well as Laurie and Gunn Carlson were very helpful in making
the Geelong visit a great success. Dave Allan was a considerate and supporting host at Edith Cowan.

Pietro Guj has finalised his contribution while holding a joint position in the WASM Mineral
Economics program and at the Centre of Exploration Targeting, which operates as a joint initiative
between the University of Western Australia, Curtin University and the mining industry with the
financial support of the State of Western Australia.

It is important also to thank the small group of senior colleagues who have joined us in reviewing key
parts of the monograph. These include Graham Davis (Colorado School of Mines), John Tilton
(Colorado School of Mines and Catholic University of Santiago), Phillip Crowson (University of
Dundee), Richie Howitt (Macquarie University), Don Larkin (The AusIMM), Allan Teede (Economic
Research Consultants) and Michael Doggett (Queen’s University).

We are very grateful for the financial support of Mannkal Economic Education Foundation and the
Adelaide, Kalgoorlie, North Queensland, Perth and Southern Queensland Branches of The AusIMM,
who have made the publication of this monograph possible through their generous sponsorship.

Last but certainly not least, we thank our wives, Mary and Luisa, for their support and encouragement.

We trust that our final product makes a positive contribution to the appreciation of mineral economics
issues in Australia and more broadly.

Philip Maxwell and Pietro Guj

May 2006

A Any factor that prevents an entrepreneur from immediately
Accrual accounting
A method of financial accounting that matches all revenue and
expenditure transactions recognised in each accounting period,
irrespective to whether the corresponding cash consideration has
changed hands during the period or not.
Ad valorem royalties
A royalty levied on the financial value of a produced mineral
resource.
Amortisation
Similar to depreciation but relating to intangible assets.
Annual equivalent value (AEV)
The ratio between a capital investment and the annuity factor for
the life of the asset at an appropriate rate of discount. AEV allows
the comparison of the capital cost of alternative assets with
different effective lives on an annual basis.
Annuity
A series of cash flows all of the same amount in each period.
Anti-trust legislation
A range of laws implemented by governments around the world
to limit the market power of firms and control how they compete
with one another. The ‘anti-trust’ terminology originates from
the United States.
Artisanal and small-scale mining
The traditional form of labour-intensive mining that continues to
persist in developing nations with significant minerals
endowments and which provides employment for many people
in poor and otherwise backward regions.
Assets
Stores of future benefits to be derived beyond the current period,
which are material and owned or controlled by the firm.
Assumed-certainty models
A DCF model in which single-point input values are assumed to
be realised with certainty. If the input values are expected or
mean values, the model will generate single-point expected
outputs and is often referred to as a base case.
Average cost
The ratio of total cost to the number of units of output that a firm
produces.
B opportunities.
Backwardation
A situation in which cash prices for immediate delivery of
minerals in a market exceed the forward price.
Balance of payments
The balance of a nation’s exports, imports, income and capital
flows in a given period.
Australian Mineral Economics
GLOSSARY OF TERMS
Barriers to entry
creating a new firm.
Base-case model
See assumed certainty models.
Bayesian (dependent) probabilities
Probability of an event given that another event, on which it is
dependent, eventuates.
β index
β is the covariance between the returns on the security and that
on the market portfolio divided by the variance of the returns on
the market portfolio. An index displaying whether and by how
much an individual security in the market portfolio amplifies
overall market movements. A β index >1 signifies that a security
is sensitive to market movements.
Binomial lattices
A graphical representation of the change in a variable that can
either go up or down in each time-step. Binomial lattices can
portray all the possible values of an asset underlying an option,
allow the calculation of the option value for each possible state
of nature (eg up, up-up, up-down, etc) and of the present value of
the option after risk neutralisation using techniques such as ‘state
prices’ or ‘risk-free probability’.
Buying pressure
This arises where consumers wish to consume more than
producers wish to produce at a given price.
By-product
A product so unimportant that its price has no influence on a
mine’s output.
C
Call option
The right, but not an obligation, to buy an asset for a specified
price on or before a specified date.
Capital Asset Pricing Model (CAPM)
A method to estimate the cost of equity (RE) necessary to attract
funds to a specific security by adding to the risk-free rate of
interest a risk-premium commensurate with the risk of the
security relative to that of a balance market portfolio.
Capital budgeting
The process of evaluating and prioritising capital investment
Capital Efficiency Index (KE)
A measure of the value added by each dollar invested, ie NPV/
CAPEX.
Cartel
A group of producers which explicitly agrees to coordinate its
production and selling activities in a given market.
215
Cash bidding
Auctioning the exploration and development rights of
well-defined tenements either for an upfront cash payment, or an
ongoing ad valorem royalty or some combination of upfront cash
and royalty payments.
Cash cleared
Users of the market do not have to contribute additional cash
when their contracts are making losses, nor can they take out
profits ahead of the prompt date. Rather, the contracts are cleared
against bank guarantees, with brokers granting credit to their
clients.
Cash costs
All fixed and variable costs sustained in cash rather than as
ledger entries when operations are taking place. They include all
site costs of mining such as stripping, processing, concentrating,
but also incorporate sales and marketing.
Certainty equivalent
The price to be received with certainty at which the holder of a
risky investment opportunity is indifferent as to whether to sell it
or to invest in it taking cognisance of their risk tolerance.
Classical or objective probabilities
Probability distributions which can be unambiguously
determined by mathematical model of the relevant processes or
by the frequency distribution of comprehensive time series or of
rigorous and statistically significant trials.
Collusion
Agreements, either tacit or explicit, between firms in an industry
on either pricing or other policies, or both, that reduce
competition between them.
Community indifference curve
A curve which shows different combinations of goods and
services corresponding to the same level of welfare in a
community, with a given distribution of income.
Company income tax
A tax on Australian companies currently computed by applying a
30 per cent tax rate to taxable company income determined
according to the provisions of the Income Tax Assessment Act.
Comparative advantage
Countries tend to export those goods and services where their
margin of superiority is greater, or their margin of inferiority
smaller, than their trading partners.
Competition policy
A range of laws implemented by governments to limit the market
power of firms and control how they compete with one another.
Similar to anti-trust legislation but this terminology is used more
widely in Europe.
Competitive markets
Markets in which prices are determined by the free interplay of
supply and demand and in which no individual producers or
buyers have the ability to influence the market clearing price.
Complements
A mineral used jointly with another mineral to produce a final
good.
216
Consumption
The process of individuals, households, business and government
using up goods and services.
Contango
Markets are in contango when prices for future delivery of
minerals exceed cash prices by a margin that represents the costs
of storage and insurance, and the rate of interest, or the time
value of money.
Contingent claim
Another term to signify an option.
Contributory share
Shares where only part of their issue value has be contributed by
shareholders who can later be called upon to contribute the as yet
unpaid balance of the issue value.
Co-product
Where two or more mined products affect a mine’s viability,
they are considered to be co-products.
Corruption
The abuse of office for private gain.
Cost-based valuation
A method of evaluation that uses the cost of acquiring an asset as
a proxy for its market price.
Cost of debt (RD)
Minimum rate of return necessary to satisfy the expectations of
providers of debt funds (lenders) to induce to lend their funds to
a firm or project consistent with the degree of security
underpinning the borrowed funds.
Cost of equity (RE)
Minimum rate of return necessary to satisfy the expectations of
providers of equity funds (shareholders) to induce to commit
their funds to an investment/project and bear its ultimate risk.
Created demand
Demand generated by continuing promotion for a final product
(eg jewellery) in which a particular mineral (eg gold) is an input.
Cross-price elasticity of demand
This shows how the quantity demanded of one mineral changes
if the price of another mineral changes.
D
Dealer market
Markets facilitated by individual dealers or commodity houses.
Depreciation
An accrual financial accounting convention to attribute the
historical, lumpy, cash capital cost incurred at the time of
acquisition of a fixed asset to the degree to which its value
decreases over successive periods while being utilised to
generate revenue in the period.
Derived demand
Demand arising because minerals, with their unique physical and
chemical properties, are used as an input into one or more final
commodities.
Australian Mineral Economics
Developed nations
Those nations with high per capita incomes and well developed
economic, governmental and social institutions.
Developing nations
Nations with less developed economic, governmental and social
institutions.
Development
A process involving major changes in social structures, popular
attitudes and national institutions, as well as the acceleration of
economic growth, the reduction of inequality and the eradication
of absolute poverty.
Differential rent
Arises where the mineral resources available for exploitation
differ in quality and grade. Different producers make different
levels of above normal profit and generate different levels of
economic rent.
Discount factor
Factor by which a sum to be received in the future is multiplied
years
by to obtain its present value, ie 1/(1 + discount rate) .
Discount rate
Rate of interest used to obtain the present value of a sum to be
received in the future.
Discounted cash flow (DCF) model
A financial model of an investment or project, which discounts
the net cash flows over the whole life of the investment back to
their present value.
Discounted payback period (DPBP)
A measure of how long it would take for an investment/project to
repay the initial capital investment with interest compound at the
appropriate rate of discount.
Distribution
The way in which a country’s citizens share the proceeds of their
production.
Dutch disease
The effects arising from the uncomfortable co-existence of
booming and lagging sectors in an economy, which often brings
significant structural adjustment, typically following the
discovery and initial exploitation of major new mineral
resources.
E Also mean value. The mean of all possible outcomes weighted
Economic growth
The growth in total production over a given period or in per
capita production of the average citizen over a given time period.
Economic rationality
An investor is said to be economically rational if they maximise
their wealth, minimise their risk, but trade risk for returns.
Economic rent
The payment that any good (commodity) or service receives in
excess of its supply price when a market is in equilibrium. It is a
surplus in excess of the minimum profit required by shareholders
in a company or firm to stay in business.
Australian Mineral Economics
Economic sustainability
Sustaining improvements in human living standards or human
material wellbeing.
Economics
The most widely used definition is that of Robbins, which argues
that economics is the science that studies human behaviour as a
relationship between ends and scarce means which have
alternative uses.
Economies in transition
Former socialist (communist) economies that have been moving
towards a more capitalist system.
Elasticity of demand
A measure of the quantitative impact on the amount of a good
demanded arising from a change of one of the other factors
affecting demand (own price, income or the price of related goods).
Elasticity of supply
A measure of the way in which the amount of minerals supplied
to a market respond to changes in key influencing factors, such
as the price of the mineral.
Engineering economics
An area of study concerned largely with the financial analysis of
engineering decisions, incorporating project evaluation, risk
analysis and related techniques.
Environmental sustainability
Sustaining environmental quality and the stock of natural
resources.
Excess capacity
This arises in established mines and smelters as a result of
reduced consumption of minerals or less than expected growth in
consumption. It has tended to act as a key barrier to entry of new
mines and mineral processing facilities.
Exchange rates
The rate at which a unit of one nation’s currency will exchange
for that of another nation.
Exercise (implementation) cost (X)
The present value (discounted at an appropriate time and
risk-adjusted discount rate) of the initial capital investment and
of all successive sustaining capital investments in a project.
Expanded NPV or ENPV
The sum of the project static DCF/NPV and of its real option
value (ROV) not captured by conventional DCF analysis.
Expected monetary value (EMV)
by their probability of occurrence.
Export levies
Taxes on exports by a host government. These may be a way to
encourage downstream production.
F
Farm-out
The contractual process of divesting of equity in a project in
consideration of cash or other forms of payment and/or
commitment to fund necessary project expenditure in preparation
for the establishment of a proper joint venture once the desired
level of equity is reached.
217
Final product
A product that is produced for its final user and not as a
component of another good or service.
Financial leverage
Enhancement of the return on equity brought about by the use of
debt in the financial structure of a firm. Leverage occurs because
of the lower cost of debt relative to equity and of the
tax-deductibility of the relevant interest expenses, albeit with the
introduction of financial risk.
Financial risk
Additional risk introduced by the use of debt in the financial
structure of a firm or project.
Financial structure
The relative proportion of equity and debt used by a firm to
finance its activities.
Financing decision
A decision as to which level of debt in the funding structure of a
project would bring about the optimal level of leverage to the
provider of equity consistent with their willingness to bear the
additional relevant financial risk.
Fiscal policy
This refers to the efforts of government to use its spending,
taxing and debt-issuing authority to smooth out the business
cycle and otherwise influence economic performance.
Fixed costs
These are costs that do not change with the level of output that a
firm produces. They cannot be varied or avoided in the short term.
Fixed exchange rates
The situation where a nation’s currency is set at a specific level
in relation to other key currencies.
Floating exchange rates
Exchange rates that vary continuously to ensure that a nation’s
exports, imports, international income flows and capital
movements are always in balance.
Flow-through share
A tax system that allows the subscriber of equity to qualifying
Canadian junior exploration companies to deduct their
contributions from their individual taxable income in Canada.
Fly-in, fly-out (FIFO)
A working pattern in mining operations involving workers
travelling long distances from their normal residences to remote
locations, working several days at the site where food and
accommodation are provided, and then travelling home for
several days of leave.
Forward contract
A binding contractual commitment to deliver (or take delivery)
of a specified quantity of a given commodity at a specified time
in the future for a price determined with certainty in the present.
Forward price
The certainty equivalent of the expected, hence risky, spot price
on the delivery date. While the price risk has been fully
neutralised the forward price still needs to be discounted by the
risk-free rate to compensate for the time-value of money and
bring it to its present value.
218
Frequency distribution
Probability distributions generated from comprehensive time
series or rigorous and statistically significant trials.
G
Gearing
See financial leverage.
Gender balance
The tendency for equal numbers of men and women to work in
the same industry, or reside in the same area.
Generalised scarcity
The idea that a product is in short supply relative to its demand.
Gold loan
An arrangement whereby a gold producer borrows gold, sells it
to fund its gold mine development and repays the loan in gold
out of future production. While the loan is outstanding the
borrower must pay a gold leasing fee, which is lower than
corresponding loan interest rates but not tax deductible.
Gross Domestic Product (GDP)
A measure of the market value of final goods and services
produced in an economy during a given period.
H
Hedging
The elimination of market price uncertainty for a mineral or
currency at a known cost.
Hicks-Marshall laws of derived demand
A series of four propositions attributed to Alfred Marshall and John
Hicks that describe the relationship between own price elasticity of
demand (for a mineral) and a range of other influencing factors.
Historical demand
Demand for minerals such as gold which arises from historical
tradition.
Homogeneous products
Products which buyers perceive to be identical.
Homogeneous regions
Regions identified because of their homogeneous economic
characteristics.
Horizontal equity
Implies equal treatment of equals and asks questions such as ‘are
miners who generate the same amount of economic rent all
paying the same amount of tax?’
Hybrids
Capital-raising instruments with the characteristics of both equity
and debt, eg convertible unsecured notes and preference shares.
I
Immediate run
A period in which the market conditions facing a mining firm are
fixed, and it is not possible to change the current rate of production.
Australian Mineral Economics
Income-based valuation
Also technical or fundamental valuation. A method of evaluation
that equates the market price of an asset to its expected net
present value.
Income elasticity of demand
This measures how the quantity demanded of a mineral changes
if consumer income increases.
Indigenous communities
Households or families with an ancient and cultural attachment
to the land where mining occurs or has an impact.
Indigenous populations
‘Existing descendants of the peoples who inhabited the present
territory of a country wholly or partially at the time when
persons of a different culture or ethnic origin arrived there from
other parts of the world, overcame them, and by conquest,
settlement or other means, reduced them to a non-dominant or
colonial situation; who today live more in conformity with their
particular social, economic and cultural customs and traditions
than with the institutions of the country of which they now form
a part, under a state structure that incorporates mainly the
national, social and cultural characteristics of other segments of
the population that are predominant …’ (UNESCO, 1982).
Individual demand curve
A graphical representation of the quantity of a good or service
that each individual demands, at various prices of this good or
service, other influencing factors being held constant.
Individual product
A geological occurrence where it is profitable only to recover
one mineral commodity from the material mined or drilled.
Inelastic demand
When a percentage change in an influencing factor leads to a less
than proportional increase in quantity demanded.
Initial public offering (IPO)
The process of listing a company on the stock exchange for the
first time by offering shares in the company to the public through
the issuing of a prospectus, with or without the offer being
underwritten by a stockbroker.
Intensity of use
The demand for a mineral (usually measured in physical units
like tonnes) per unit of income discounted.
Intergenerational equity
In the minerals and energy sector this is concerned with whether
depletion of mineral resources leaves future generations without
the ability to earn comparable levels of income as the asset stock
inherited by future generations is diminished.
Internal funding
Cumulative retained earnings and proceeds from asset sales.
Internal rate of return (IRR)
A measure of the return per dollar invested – the rate of discount
at which the NPV of an investment/project becomes zero.
International trade
Trade that occurs between nations.
Interregional trade
Trade that takes place between regions within a nation.
Australian Mineral Economics
Investment
Spending on capital formation, both physical and human.
Investment decision
A decision as to whether to invest or not based on a DCF model
under 100 per cent equity assumptions.
J
Joint venture
A form of unincorporated or corporate contractual arrangement,
where participants share the costs of a project and the products
(not the profits) of the project according to agreed formulae
(generally in proportion to their equity). Joint ventures are
distinguished from partnerships in that JV participants,
individually and severally, are liable and taxable.
JORC Code
Australasian code for reporting of mineral resources and ore
reserves prepared by the Joint Ore Reserve Committee (JORC)
comprising The Australasian Institute of Mining and Metallurgy
(AusIMM), the Australian Institute of Geoscientists (AIG) and
the Minerals Council of Australia (MCA).
L
Law of demand
The proposition that, other things being equal, if price goes up,
quantity demanded will decrease; and if price goes down,
quantity demanded will increase.
Liabilities
Future sacrifices of financial benefits that the firm is presently
obliged to make to other entities as a result of past transaction or
other events.
Liquidity
The capacity of a firm to satisfy its debt and liabilities with cash
when they fall due.
List prices
The publishing of indicative mineral prices, mainly for minor
metals and some industrial minerals. This often takes place in
industry newsletters or other trade journals.
Location rent
A similar concept to differential rent.
London Metal Exchange (LME)
The leading terminal market for trading non-ferrous metals. It
accounts for over 90 per cent of global exchange business for
those metals it trades. These are aluminium, aluminium alloy,
copper, lead, nickel, tin and zinc.
Long run
A period in which all the market conditions facing a mining firm
can change. ‘New mines can be developed and processing
facilities built, and firms can expand the capacity of existing
operations’.
Long-term contracts
These apply in mineral markets such as coal and iron ore. They
fix prices for agreed delivery of output for periods of a year or
more, or they index prices according to an agreed formula.
219

M The ability of a producer to set prices above competitive levels,
Macroeconomics
The study of the operations of national economies and the world
economy. Its focus has been on measures of economic
performance such as Gross Domestic Product, inflation,
investment, saving, economic growth and the balance of
payments.
Main product
A product so important to the economic viability of a mine that
its price alone determines a mine’s output.
Management flexibility
Management capacity to dynamically change the course of a
project in response to emerging information dispelling
uncertainty, ie learning with the benefit of hindsight.
Marginal benefit
The amount of money that someone is willing to pay to enjoy the
attributes of an additional unit of a good or service.
Marginal benefit curve
A curve that plots marginal benefits for each additional unit of a
good or service. This is the same as an individual’s demand
curve for a good or service.
Marginal cost
The change in the total cost of production from producing an
additional unit of output.
Marginal physical product
This is the increase in output generated by adding an additional
unit of the variable input.
Marginal revenue
The change in total revenue that a producer receives from selling
an additional unit of output.
Marginal revenue product
The additional revenue associated with adding a further unit of a
variable factor of production (eg a mineral).
Market-based valuation
A method of evaluation based on observable or imputable market
prices.
Market capitalisation
The value placed by the stock market on a company, ie its
number of issued shares times their current spot price.
Market demand curve
This shows the total number of units of a good or service that
buyers are willing to purchase in a market at every possible price
during a given period. It is also the sum of all individual demand
for a good or service.
Market equilibrium
A situation where the price of a good or service is such that the
quantity that buyers want to buy is the same as the quantity that
sellers want to sell.
Market portfolio
A portfolio containing all listed security balanced in terms of their
market capitalisation (eg All Ordinaries Index) and returning a
rate of RM.
220
Market power
so that greater profit can be generated.
Market premium (RM - RF)
The degree to which the return on the balanced market portfolio
RM exceeds that on bonds RF.
Market risk
Also systematic or non-diversifiable risk. That part of the
volatility of the returns on an investment that is due to
economy-wide factors and that cannot be diversified.
Market share
Obtaining and holding a nominated percentage share of a mineral
market, a common corporate objective of many large and small
mineral producers.
Market structure
The competitive nature of the market for a particular mineral is
influenced by the number of buyers and sellers and their
respective market power. Markets can range from being perfectly
competitive with many buyers and sellers to monopolistic and
monopsonistic.
Market supply curve
This shows the total number of units of a good or service that
sellers are willing to deliver to the market at every possible price
during a given period.
Material composition of products
The amount of minerals used to produce goods and services in an
economy.
Maximisation rule
The value of an option is never zero, ie for a call max(S-X, 0)
and for a put max(X-S, 0).
Microeconomics
The study of economic decision-making by consumers,
households and firms, and the way in which these relate to the
operation of markets.
Mineral economics
The application of economics in the study of all aspects of the
mineral sector.
Mineral market demand curve
This shows how much of a mineral buyers are willing to
purchase at every possible price during a given period. It is
typically not the horizontal sum of individual demand curves
because of a ‘final product’ effect on mineral demand.
Mineral policy
Rational development of mineral and energy resources to
achieve the broad economic goals of government.
Mineral rent
The returns in excess of those needed to attract factors of
production into the mining industry in the long run. It is the
revenue remaining after all costs have been deducted. These
costs include exploration outlays, expenditures on mine
establishment and cash operating costs.
Mineral reserves
Those ‘quantities of a mineral commodity in subsurface deposits
that are known and profitable to exploit, given existing
technology and prices’.
Australian Mineral Economics
Mineral resources
Mineral reserves; together with deposits that are: economic but not
yet discovered; or expected to become economic as a result of new
technology or other developments within the foreseeable future.
Modern asset pricing (MAP)
An evaluation technique whereby the riskier revenue function is
separated from the less risky cost function and its price risk
neutralised by the use of forward prices. These are either obtained
from LME quotes or forecast using a Geometric Brownian Motion
stochastic model. The two functions are then recombined and
discounted to present value using the risk-free rate of interest to
compensate only for the timing of the cash flows.
Monetary policy
Deliberate action by government setting interest rates or
otherwise controlling the money supply to influence the
performance of the economy.
Monopoly
A market in which there is one supplier who can control either
the amount supplied or the price of the product.
Monopoly rent
The excess profits which monopolistic producers generate because
they have induced scarcity or restricted supply of a good or service.
Monte Carlo simulation
A computer-assisted simulation based on generating a large number
of scenarios by sampling various inputs simultaneously and
randomly, but according to their respective probability distribution
of occurrence. Monte Carlo simulations generate a probability
distribution of all possible values of the output being simulated.
Multiple or chooser option
An option offering a number of mutually exclusive alternative
courses of actions, which must be exercised by the same expiry
time, or continuation of the status quo.
Multipliers
A measure of the total impact on a variable such as spending,
income or employment of a unit increment or decrement to this
variable.
N Monetary terms incorporating the effect of inflation.
Nationalisation
The process of moving from private to public ownership of key
industry sectors in a nation.
Native title
Traditional rights of access, use, or occupation concerning lands
or waters. They are personal or group rights based on traditional
laws or customs (Horrigan).
Natural capital
The stock of environmentally provided assets such as the soil,
minerals, the atmosphere, the forests, wildlife and water.
Negative externalities
Those costs of resource exploitation activity that are not borne
by the mine operator in the form of costs of production which
have to be covered by mine revenue. Rather they are costs borne
by society as a whole through, for example, pollution or
environmental degradation.
Australian Mineral Economics
Net cash flow
The difference between all cash inflows and all cash outflows for
a specific asset over a specific period.
Net present value (NPV)
The sum of the present values of all the net cash flows to be
received from an investment/project in the future after
discounting at an appropriate rate of discount.
Net smelting return (NSR)
The value of concentrate free on board (fob) mine (free on board –
after deducting smelting and refining charges levied by the custom
smelters and the relevant transport costs).
New scrap
‘When metals are converted into shapes – bars, plates, rods,
sheets, etc new scrap is generated in the form of turnings,
stampings, cuttings and off-specification materials’ (USGS).
New York Mercantile Exchange (Nymex)
Trades in futures and options contracts for crude oil, gasoline,
heating oil, natural gas, electricity, gold, silver, copper,
aluminium and platinum; futures contracts for coal, propane and
palladium; and options contracts on the price differentials
between crude oil and gasoline, crude oil and heating oil, Brent
and West Texas Intermediate crude oil and various futures
contract months (calendar spreads) for light, sweet crude; Brent
crude; gasoline; heating oil; and natural gas (Nymex, 2006).
No-arbitrage
In frictionless and efficient markets assets generating cash flows
of the same magnitude and timing and having the same risk must
have the same market price. If this were not the case,
arbitrageurs could buy a lower priced asset in one market and
sell it at a higher price in another, thus making a risk-free profit.
In reality arbitrage opportunities are short-lived, as prices rapidly
adjust.
Nodal regions
Regions identified according to the ‘magnetic’ attraction of a key
nodal centre for the economic and cultural activities of people
living in the surrounding area.
Nominal money terms
Also historical dollars, dollars of the day or out-turn dollars.
Non-monetary values
Socio-economic values not directly measurable in monetary
terms, but through techniques known as shadow pricing. Also
see utility values.
Non-renewable resource
A resource with a rate of natural replenishment is so low that it
does not provide any hope of replenishment within a reasonable
time period.
No-recourse finance
See project finance.
Normal profit
A profit level just sufficient to keep a producer operating in a
particular industry and not moving to another competitive
industry. Normal profits apply in competitive markets but above
normal profits are typical in other market forms.
221

O A measure of the mix of goods being produced in an economy.
Occupational communities
Those households or families who derive all or most of their
income from mining.
Old scrap
Mineral supply obtained from products that have reached the end
of their useful lives.
Oligopoly
Markets dominated by a few selling firms, where there are
substantial barriers to entry.
Oligopsony
A market in which there are a small number of buyers.
Option
The right but not the obligation to buy (or sell) an asset for a
specified price on or before a specified time.
Organisation of Petroleum Exporting Countries (OPEC)
The group of major oil producers, led by Saudi Arabia, which
has influenced oil prices and output in the world since the early
1970s.
Own-price elasticity of demand
This measures how the quantity demanded of a mineral changes
if its price changes.
P regions.
Price risk
Risk attributable to the volatility of the price of the product/
commodity produced.
Price takers
A situation where mineral producers exert little or no influence
on the prevailing market price for their production. This occurs
particularly in purely competitive markets.
Price volatility
The tendency for market prices to move up and down and by
large relative amounts in relatively short time periods.
Price wars
A situation in which cartel and non-cartel members undercut
nominated cartel prices, typically during periods of reduced
product demand in a business cycle downturn. Such actions may
lead to the effective end of cartel arrangements or other collusion
between producers.
Probabilistic models
DCF models in which probability distributions of possible input
values are used instead of single-point estimates. These models
are used to carry out Monte Carlo simulations generating
probability distributions of outputs.
Producer pricing
A market in which dominant companies nominate the selling
price of a mineral.
222
Product composition of income
Production
The process of converting economic resources to useful final
goods and services.
Production function
Describes the technical relationship regarding the generation of
final key factor inputs such as land, labour, capital and technology.
Production possibility curve
A curve showing different maximum combinations of goods and
services that society can produce if all factors of production are
fully employed during a given period.
Project finance
A form of often syndicated, debt-financing package, tailor made
for mining project development and serviced and secured
primarily by the cash flow generated by the project it is funding.
True no-recourse arrangements with no claim on the broad
corporate assets of the company promoting the project are rare
because of covenants and other conditions often imposed by the
lenders restricting the ability of the borrowers to further borrow
or raise equity and pay dividends.
Project risk
Risk that is unique to a project given its characteristics.
Prospectus
See initial public offering (IPO).
Purchasing power parity
A measure of cost of living differences between nations and
Put option
The right but not an obligation to sell an asset for a specified
price on or before a specified date.
Q
Quasi-rents
Rents that emerge because of changes in consumer tastes, new
products and new methods of production but which eventually
disappear as more production comes on stream.
R
Real money terms
Monetary terms disregarding the effect of inflation, ie attributable
to the acquisition power of the currency at a specified point in
time and kept constant over successive periods irrespective of the
presence and magnitude of inflationary effects.
Real option value (ROV)
The value of the inherent or designed managerial flexibility in
projects. It arises because decision-makers can dynamically
change their actions in response to emerging information
resolving uncertainty as the project unfolds, ie learning and
acting with the benefit of hindsight. ROV is not captured by the
static DCF/NPV view of the project and must be added to the
NPV to obtain a more realistic measure of project value, ie of its
Expanded NPV or ENPV = NPV + ROV.
Australian Mineral Economics
Registered warehouses
In 2004 the London Metal Exchange maintained a series of 36
warehouses in major centres around the world, serving as stores
for the metals which it traded.
Renewable resource
A resource that can be replenished naturally with the passage of
time.
Replicating portfolio
For each optional claim on a risky asset one can construct a
portfolio made up of a risky asset and risk-free bonds that
exactly replicated the cash flow outcome of the risky asset.
Residential communities
Households or families who live in the geographical area affected
by mining.
Resource curse
The paradoxical finding that natural resource abundance is
negatively related to an economy’s economic performance.
Resource rent tax
A tax that seeks to identify economic rents by allowing the
deduction of all costs of production from revenue, including
normal profit, and then taking a share of any resulting rents.
Risk
The extent to which the uncertainty of a variable affects the
returns on an investment or project.
Risk attitudes
Also risk profile. The influence on an investor of the chance of
making a monetary loss underlying a risky investment. If the
magnitude of the potential loss is large relative to the investor’s
wealth, the investor will display a risk-averse attitude otherwise
he will be risk-neutral, ie indifferent to money.
Risk-free probability
A user-friendly and versatile mathematical algorithm designed to
neutralise risk and to discount binomial lattice option values to
their present value of an option.
Risk-free rate of interest (RF)
The rate of return necessary to attract investment to risk-free
borrowing instruments, typically government bonds.
Risk management
A set of corporate rules designed to minimise the potential
impact of risk, ie the severity of consequences of possible events
weighted by their probability of occurrence.
Risk-neutral
A risk-neutral investor will select investment opportunities with
the maximum expected value irrespective of the underlying risk.
Risk of Gambler’s ruin
The probability that the risk capital is insufficient to support a
large enough number of risky investments providing sufficient
confidence that the returns generated will be adequate to sustain
the financial viability of the firm thus avoiding bankruptcy.
Risk-tolerance
The degree to which an investor can bear risk, as measured by its
risk capital or risk tolerance coefficient (RT).
Risk-tolerance coefficient – See risk tolerance
Australian Mineral Economics
S
Saving
The amount of money generated from abstaining from
consumption in any given period.
Scenario analysis
The determination of the effect on a model output of changing the
value of selected combinations of inputs, generally pessimistic or
optimistic, to portray possible future State of Nature.
Securitise
The process whereby arrangers of syndicated project finance
hedge some or most of the project risk in order to enable them to
borrow at lower secured rates of interest on the Eurobond or
other similar financial markets.
Selling pressure
This arises where consumers wish to consume less than
producers wish to produce at a given price.
Sensitivity analysis
The determination of the effect on a model output from changing
the value of any input.
Sequential/compound options
A series of options with successively longer expiry times, where
exercise of longer-term options is conditional on having
exercised earlier shorter-term ones on which they are dependent.
Shareholders’ equity
Also net worth. The difference between all the assets and all the
liabilities of the firm. In accounting terms shareholders’ equity
comprised the equity capital contributed by the shareholders and
cumulative earnings retained by the firm.
Short run
A period in which the market conditions facing a mining firm are
fixed. These include the firm’s lease, its existing production
capacity, employment contracts, and several other operating
conditions. A firm can vary its rate of production but it cannot
exceed its current mine capacity.
Shorter-term contracts
Contracts less than a year, which set prices for agreed purchases
of mineral output.
Single option
An option offering a new course of action or continuation of the
status quo.
Social and cultural sustainability
Fairness in the distribution of benefits and burdens associated
with economic activities to all participating interest groups.
Social impact analysis (SIA)
The process of assessing or estimating, in advance, the social
consequences that are likely to follow from specific policy
actions or project developments.
Socio-economic indexes
Measures typically computed by central statistical agencies such
as the Australian Bureau of Statistics, which measure particular
social characteristics of a population.
223
Solvency
A firm is solvent if the value of its assets exceeds that of its
liabilities.
Sovereign risk
This arises when host governments arbitrarily change the laws to
impose tax burdens, or other operating rules and regulations that
were not indicated originally.
Specific royalties
A royalty levied on the physical rather than the financial measure
of a mineral resource.
Spider web diagram
An effective diagrammatic way of portraying sensitivity analyses.
Spot price or project payoff (S)
The present value (discounted at an appropriate time and
risk-adjusted discount rate) of all net, after-tax operating cash
flows generated by the project over its whole life.
State price
What an investor is prepared to pay for a ‘state asset’, ie for a
contingent claim that pays $1 with certainty if the up state is
realised at the end of the period or zero if the down state eventuates.
Substitute good
A good that be used as an alternative to another good because it
possesses a similar range of attributes.
Sustainable development
The simultaneous pursuit of sustained or enhanced: environmental
quality, economic growth and social justice.
Swap
A contractual arrangement to pay a slightly higher rate of fixed
interest to convert a variable-interest-rate loan into a fixed-rate one.
Systematic risk
Risk that depends on economy-wide factors and cannot be
diversified away by the portfolio effect.
T maximising his or her happiness, both intellectual and sensual.
Tax base
The object from which a tax is being sought.
Tax neutrality
This arises when the system that collects economic rent from a
mining company has no effect on its production decisions.
Tax rate
The rate applied to the base to calculate mineral revenue proceeds.
Taylor’s rule
An empirical method to estimate the optimal mine life based on
diluted mining reserves, ie mine life (years) = 6.5 * (diluted
0.25
mining reserve (Mt)) . The mine life is generally reduced by
up to 25 per cent if mining is carried out by contractors.
Terminal markets
Mineral markets such as the London Metal Exchange and the
New York Mercantile Exchange where prices are set, at least on
a daily basis, to balance that day’s marginal offerings and
demand. These markets also perform a variety of other functions.
224
Term of option (t)
Time during which managerial flexibility is open.
Terms of trade
The ratio of the prices of the goods and services that a nation
exports to the price of the goods and services that it imports.
Terra nullius
Land belonging to no one.
Tornado diagram
An effective diagrammatic way of portraying the results of
sensitivity analyses, based on possible ranges of input values, in
a manner that ranks the tested inputs in order of decreasing
influence on the output of the model.
Trade
A process of exchange between individuals, business and
governments, which generally makes each participating party
better off as a result of the transaction.
Trade liberalisation
The movement towards freer trade between nations.
Trade-Weighted Index
A weighted average of a basket of currencies that reflects the
importance of the sum of a nation’s exports and imports of goods
by country.
Transfer prices
These apply where firms, who control different stages of
downstream processing of a mineral through vertical integration,
make sales of mineral output at agreed prices to other branches
of the firm. Governments monitor these prices closely to try to
ensure that their levels do not reduce profits and the ability of a
firm to pay company taxes.
U
Utilitarian philosophy
The view that each person makes decisions with the objective of
Utility
Each expected dollar value (X) has a reduced ‘utility’ value u(X),
which depends on an individual investor’s preferences and risk
tolerance coefficient (RT).
Utility function
An algorithm that derives the utility value u(X) as a negative
exponential function of the expected monetary value to be
received (X) divided by the individual investor’s risk tolerance
coefficient (RT).
V
VALMIN Code
Code for the technical assessment and valuation of mineral and
petroleum assets and securities for independent expert reports,
prepared by the VALMIN Committee, a joint committee of The
Australasian Institute of Mining and Metallurgy (AusIMM), the
Australian Institute of Geoscientists (AIG) and the Mineral
Australian Mineral Economics
Industry Consultants Association (MICA), with the participation
of the Australian Stock Exchange Limited (ASX), the Australian
Securities and Investment Commission (ASIC), the Minerals
Council of Australia (MCA), the Petroleum Exploration Society
of Australia (PESA), the Securities Institute of Australia (SIA)
and representatives from the Australian finance sector.
Value adding argument
The proposition that mineral producers should engage in
downstream processing of these minerals within their borders to
increase the benefit to the nation’s citizens.
Value additivity
Different elements of a DCF model can be separated, appropriately
discounted and recombined to derive a project NPV.
Value at risk (VaR)
A probabilistic method to determine the maximum possible loss
that may be incurred at a given level of confidence over a
specified time horizon.
Value consistency
In arbitrage-free markets assets generating cash flows of the
same magnitude and timing and having the same risk must have
the same market price.
Variable costs
These are costs that change with the level of output that a firm
produces.
Australian Mineral Economics
Venture capital
Forms of unlisted equity funding to address the high-risk initial
stages of projects provided by venture capitalists.
Vertical equity
Concerned with whether miners who generate different amounts of
economic rent are treated differently in the amount of tax they pay.
Very long run
A period in which the constraint imposed by existing known
mineral deposits no longer holds and firms have the time to
conduct exploration and find new deposits. In this time period
emerging technology, induced either by the exhaustion of known
deposits or higher metal prices or both, may also permit the
exploitation of new types of deposits.
Volatility (σ)
Standard deviation of the logarithm of the return from holding an
asset.
W
Weighted average cost of capital (WACC)
A method to estimate the corporate cost of capita (RC). It weights
the cost of debt (before or after tax) by the proportion of debt to
total funds and the cost of equity in proportion to total funds in
the financial structure of the firm.
225
 Contents
1. Mineral Economics — An Introduction Philip Maxwell

Definitions of Economics and the Economic Way of Thinking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Economics and Mineral Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Focus of Mineral Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Some Key Questions in Mineral Economics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
The Structure of this Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Minerals and the World Economy

2. Minerals, Growth and Development Philip Maxwell

Some Foundations – Mineral Exploitation, Production, Distribution, Consumption, Trade and Related Economic
Concepts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Economic Growth and Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Periods of History and Minerals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Economic Development and Mineral Resources – The Traditional View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
The Australian Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Complicating Factors with Mineral Production and Consumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Appendix – A Classification of Developed and Developing Nations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3. Minerals and the Developing Nations Philip Maxwell

Mineral Dependent Developing Nations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

The Impact of New Mineral Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
External market forces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Internal economic stresses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Distorted processes of policy making. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
The Resource Curse Hypothesis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Institutional and Policy Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

4. Trade in Minerals Philip Maxwell

Why Trade Takes Place . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

The World Economy, International and Interregional Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Recent World Production and Trade in Minerals and Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Australian Production and Trade in Minerals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Transport Costs and the Direction of Minerals and Energy Trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Minerals Trade and Exchange Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
 Minerals — Consumption, Production and Markets

5. Mineral Demand — The Theory in Practice Peter Howie

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
The Final-Product Demand Curve and the Level of Consumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Final-product demand and its determinants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Mineral Resources and Derived Demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
The mineral demand curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Shifts of the mineral demand curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Elasticity of Mineral Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Own-price elasticity of mineral demand in the short run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Income elasticity of mineral demand in the short term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
Cross-price elasticity of mineral demand in the short term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Elasticity of mineral demand in the long run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

6. Mineral Supply — Exploration, Production, Processing and

Recycling Philip Maxwell

Some Introductory Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

Short-run and long-run supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
The mineral supply process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Supply curves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Resources and Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Mineral Supply – Individual Products, Main Products, Co-Products and By-Products . . . . . . . . . . . . . . . . . . . . . . 51
Key Determinants of New Mineral Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Individual and main products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
By-products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Co-products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Secondary Materials – The Economics of Recycling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
The supply of new scrap minerals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Old scrap mineral supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Total Mineral Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

7. Mineral Markets, Prices and the Recent Performance of the

Minerals and Energy Sector Phillip Crowson

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Market Structure – Competitive Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Market Structure – Oligopolistic Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
The Rise and Fall of Cartels. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Producer Pricing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Terminal Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
The London Metal Exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Recent Trends in Mineral Markets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
8. The Mineral Sector Workforce Philip Maxwell

A Global Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
The formal mining sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
Artisanal and small-scale mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
Mineral Sector Employment in Australia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Historical trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Employment, value added and capital intensity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Salaries, wages and employment levels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
Occupational and educational structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Location issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
Important Mineral Sector Workforce Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Gender imbalance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Maintaining a supply of well-trained professionals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
The growth of fly-in, fly-out workforces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
Summary and Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Mineral Finance and Investment

9. An Introduction to Mineral Finance Pietro Guj

Financial Objectives and Financial Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

The role of financial managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
Sources and Application of Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
General considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
Main sources of funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Sources of Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
General considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
Off-market sources of initial equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
On-market sources of equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
Resource sector IPOs are generally small . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
Criteria for inclusion in a stock market index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Innovative investment vehicles for the resources industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Fiscal incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
Joint venture farm-outs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
Specialty finance (royalty) companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
The Cost of Equity: Balancing Risk and Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
Sources of Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Some general considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
Short-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Hybrids Between Equity and Debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Project Finance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Some introductory considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
 Risk underpinning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
The Financial Structure of Mining Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Cost of debt, financial leverage and financial risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Financial structure of mining companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

10. Mineral Project Evaluation — An Introduction Pietro Guj

What is it Worth? – Types and Uses of Financial Valuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99

General issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
Market and cost-based evaluations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
Fundamental or technical evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
Income-Based Valuations and Discounted Cash Flow (DCF) Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
The basic DCF model structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
Constructing a simple DCF model of a mine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101
Project valuations are at a point in time – discounting cash flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103
Reconciling cash and financial accounting accrual figures in a DCF model . . . . . . . . . . . . . . . . . . . . . . . . . . . .104
Modelling Debt and Financial Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105
Comparison of Mutually Exclusive Projects with Different Lives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107
Lease or buy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .108
Inherent Weaknesses and Common Traps in DCF Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .109
Identifying and Quantifying Financial Risk: Expected Value, Sensitivity and Scenario Analyses . . . . . . . . . . . . . .110
Probabilistic Models and Financial Simulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .111

11. Preliminary, Prefeasibility and Feasibility Studies Rick West

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .113
The Phases of a Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114
Testing the Data – Technical Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114
Types of Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115
The feasibility study is an iterative process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115
Scoping or conceptual studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .115
The prefeasibility study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116
The feasibility study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117
Bankable feasibility studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .117
Definitive project cost estimates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118
Owner management activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118
Project management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118
Applicable codes and professional competency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118
Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
Capital costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119
Operating costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120
Market Surveys and Commodity Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121
Financial Evaluation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121
 The cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .121
Project optimisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122
Some Comments on Cut-Off Grades and Other Cut-Off Points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .122
Risks and Sensitivities Associated with Feasibility Studies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123
Risks associated with the project’s resource base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123
Mining and processing risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123
Project design and construction risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Financial and marketing risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Capital costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Operating costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Commodity prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Project sensitivities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .124
Managing risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125
Managing the Feasibility Study Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125
Feasibility Study Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .125
Appendix – Checklist of the Main Sections of Feasibility Study Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .126

12. Mineral Project Evaluation — Dealing with Uncertainty and Risk Pietro Guj

Introduction: Beyond DCF/NPV Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129

Attitudes to Risk – From Expected Value to Expected Preference Value (Certainty Equivalents) and Pricing of
Risky Projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
Understanding the nature of risk and risk-neutral expected returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .129
From risk-neutral to risk-averse investment decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .130
Risk exposure and value at risk (VaR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .131
Risk preferences and the price of risky investment opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .131
Risk Spreading Through Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .133
Bayesian Decision Trees and Progressive Risk and Value Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .134
Modern Asset Pricing (MAP) Using Commodity Forward Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137
No-arbitrage and replicating portfolios principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .137
Commodities forward prices as certainty equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .138
From Static DCF/NPV to Dynamic Real Option Valuations (ROV) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .140
A different logic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .140
Types of real options in mining projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .140
The market has been effective at setting real option values – considering the case of Sally Malay . . . . . . . . . .141
Estimating the real option value of the Sally Malay project in September 2001 . . . . . . . . . . . . . . . . . . . . . . . . .142
Using Binomial Lattices in Real Option Valuations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .142
Valuing an Expansion Option with the Binomial Lattice Method Using the ‘Risk-Free Probability’. . . . . . . . . . . .144
Valuing Tonnage-Grade Trade-Offs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145
Evaluating the Sequential and Compound Real Option Value of Mineral Exploration Farm-In/Options
Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .146
Strategic ROV Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .148
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .148
 Minerals and Public Policy

13. Mineral Policy — An Introduction Philip Maxwell and Pietro Guj

The Aims and Practice of Economic Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153

The Context of Mineral Policy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .154
Mineral Policy in Practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
The Transition of Mineral Policy since 1950 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156
The post-1960 surge in public ownership. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .157
The swing back to private ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158
Some current policy realities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158
Towards a competitive regulatory and fiscal regime for exploration and mining . . . . . . . . . . . . . . . . . . . . . . . .158

14. The Legal and Regulatory Environment of Mining Gavin Jahn

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161
The Australian Federation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161
Inconsistency Between State and Federal Laws. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162
The meaning of law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162
Commonwealth Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162
The corporations power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162
Industrial relations power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163
Export power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163
External affairs power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164
Race power and native title . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164
Native title legislation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165
Native title claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165
Validity of the tenements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .165
State Legislation – The Western Australian Situation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Mining Act 1978 (Western Australia). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Mining tenements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
The mining lease (ML) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
The exploration licence (EL). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Renewals and extensions of tenements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Special agreement acts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Mine Safety and Inspection Act 1994 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Aboriginal Heritage Act 1972 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167
Appendix – Validity and Consistency Under Section 109 of the Australian Constitution . . . . . . . . . . . . . . . . . . . .168
Invalid. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
The tests for inconsistency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168
Repugnancy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168
The Commonwealth permits or confers: the state prohibits or deprives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168
Covering the field test. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168
 The field. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169
Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169

15. Mineral Taxation and Royalties Frank Harman and Pietro Guj

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171
Minerals sector taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171
Contents of this chapter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .171
A note on terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .172
Why are there special taxation and royalty regimes for the minerals sector? . . . . . . . . . . . . . . . . . . . . . . . . . . .172
Economic Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .172
Economic rent and normal profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .172
Economic rent and scarcity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173
Economic rent, scarcity and the minerals sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .173
Pursuing economic rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .174
Relevant Constitutional Powers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .174
Ownership and control of mineral resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .174
Powers to raise mineral taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175
Design Principles for the Taxation of Mineral Rents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175
Economic efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .175
Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176
Administrative cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Stability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Current Mineral Taxation Regimes in Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Taxes designed to capture economic rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .176
Tax and royalty regimes in the Australian states, the Northern Territory and the Commonwealth. . . . . . . . . . . . . . 1
. 77
Queensland . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177
New South Wales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177
Victoria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
Tasmania . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
South Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
Western Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178
Northern Territory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .179
The Commonwealth of Australia. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .179
Other issues in the collection and use of economic rents in Australia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Export levies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Rail freight rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Pipeline licence fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Infrastructure contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Cash bidding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Government equity participation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
Hybrid resource rent tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Using economic rents for the future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Net impact of Australian federalism on state royalty revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
 Evaluating Australian Mineral Taxation and Royalty Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Assessment of different taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Specific royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Ad valorem royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Profit based royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .181
Rent-based regimes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182
Problem areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182
Commonwealth Company Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182
Deductibility of exploration expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .182
Depreciation of capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .183
Other issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .183
Mineral Revenue Policies for the Future . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .183

16. Mining, Sustainability and Sustainable Development Roderick Eggert

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187
Sustainability and Sustainable Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187
Mining and Environmental Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188
Mining and Economic Sustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189
Mining and Social Justice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .189
Public Policy: Principles and Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .190
Putting Sustainability and Sustainable Development into Practice in Mining . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .192
Final Thoughts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .193
Appendix A – The Mining, Minerals and Sustainable Development Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .193
Nine key challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .193
Appendix B – Summary Findings of the Extractive Industries Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
Appendix C – Ten Principles of the Global Compact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
Human rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
Labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194
Environment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194
Anti-corruption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194

17. Mining and Indigenous Populations Philip Maxwell

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .195
Aboriginal Australia – Some Historical Background. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196
Aboriginal Australia – Some Recent Comparative Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .197
Mining and Aboriginal Australia – Pre Mabo . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .199
Howitt’s study of Roebourne . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .199
Dillon’s study of Argyle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .201
Mining and Aboriginal Australia – The Mabo Case and Recent Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . .202
The trend towards negotiated agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .204
Looking to the Future. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .204
18. Minerals and Regional Development Philip Maxwell

Some Introductory Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .207

Mining – Towns, Cities and Regions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .208
The Australian Regional Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .209
Mining and Australian Regional Development – A Historical Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210
Socio-Economic Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210
Assessing Economic Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212
Assessing Social Impacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .213
Fly-In, Fly-Out and Regional Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .213

Glossary of Terms 215

Subject Index 227

Name Index 247


Mineral Economics — An Introduction
Philip Maxwell
Definitions of Economics and the Economic Way of Thinking
Economics and Mineral Economics
The Focus of Mineral Economics
Some Key Questions in Mineral Economics
The Structure of this Volume
DEFINITIONS OF ECONOMICS AND THE
ECONOMIC WAY OF THINKING
Economics, and the economic way of thinking, have had an
important influence on business and government affairs for at
least the last two centuries. The Scottish author Adam Smith
espoused the foundations of modern economic thought in 1776
(Smith, 1976 [1776]). His famous volume – The Wealth of
Nations1 – ushered in a revolution in economic thinking. His
ideas formed the basis of the new academic field of political
economy, which writers such as William Stanley Jevons renamed
as economics some 100 years later.
In the early pages of his book, The Worldly Philosophers,
Heilbroner (1972) traces the rise of economics to the emergence
of the market system in the wake of the Industrial Revolution,
which began in the middle of the 18th century. Prior to that time,
the organisation and survival of society had largely depended on
tradition and authoritarian rule.
The discipline of economics developed strongly during the
20th century, with economists applying its principles to many
areas and industries. One of these industries was mining. For at
least the last 50 years, undergraduate students in mining
engineering programs around the world have taken one or more
courses in mineral economics or engineering economics as part
of their curriculum. Graduate coursework programs in mineral
economics have also developed in a number of well-known
universities.
As one might expect, mineral economics is ‘the application
of economics in the study of all aspects of the mineral sector’
(MacKenzie, 1987, p 2). To understand its focus more clearly,
however, it is necessary briefly to consider the definition of
economics, and its evolution.
One of the most widely used early definitions of economics
was that of Alfred Marshall, in his influential volume, The
Principles of Economics. Marshall (1890, p 1) notes that:
POLITICAL ECONOMY or ECONOMICS is the
study of man in the ordinary business of life; it
1. Its full title is An Inquiry into the Nature and Causes of the Wealth of
Nations (Smith, 1976 [1776]).
Australian Mineral Economics
CHAPTER 1
examines that part of individual and social action
which is most closely connected with the
attainment and with the use of the material
requisites of wellbeing.
Thus it is on the one side a study of wealth; and
on the other, and more important side, a part of
the study of man.
This is a broad definition and, as such, it attracted debate. In
seeking to clarify the nature of economics, Robbins (1932, p 16)
offered a different perspective with his so-called ‘scarcity’
definition as opposed to Marshall’s ‘materialist’ definition. This
was that:
Economics is the science which studies human
behaviour as a relationship between ends and
scarce means which have alternative uses.
Most writers of modern principles economics textbooks have
embraced this scarcity definition. Without scarcity, there would
be no need for markets. Everything would be free and
uncontested. It provides a reference point for new students to
consider and digest the subsequent theories and models of
classical and neoclassical economics, the two major schools of
thought. They present it in a slightly extended version such as:
Economics is the study of how people and society
choose to employ scarce productive resources to
produce goods and services and distribute them
among various groups in society (Waud et al,
1996, p 6).
This is, however, not the last word. Non-traditional
economists, such as John Kenneth Galbraith take an even broader
view. In his volume The New Industrial State, Galbraith (1978,
p 417) notes that:
In economics:
• Economic theory – the study which deals with
the way prices, output and incomes of
individuals, firms and the economy at large
are decided – is one area of specialisation.
• The corporation is another.
1
CHAPTER 1: MINERAL ECONOMICS — AN INTRODUCTION

• Decision theory – how decisions are reached TABLE 1.1

in complex organisations – is yet another and The size of the minerals sector in selected economies and the
more modern field. extent of international minerals trade – 2001. Source: World Bank
(2004), various.
Writers in the field of mineral economics such as MacKenzie
(1987), and practitioners more generally, have tended to embrace Country Minerals Total GDP Minerals Mineral
a broader definition in the Galbraithian mould. Why and how this GDP (US$ B) GDP/Total exports/Total
has happened is considered in the third section of this chapter. (US$ B) GDP exports
Before doing so, consideration is given to the place of mineral USA 150 9780.8 0.015 0.04
economics in the broader context of the study of economics more Japan 81.4 4523.3 0.018 negligible
generally.
Germany 40.2 1939.6 0.021 0.007
China 45 1131.2 0.04 0.04
ECONOMICS AND MINERAL ECONOMICS
India 14.5 477.4 0.03 0.09
The rise of economics during the 20th century has occurred in
Australia 17.2 410.0 0.042 0.36
several dimensions. At one level there has been division of the
discipline between microeconomics and macroeconomics. Brazil 7.6 508.9 0.015 0.21
Microeconomics is the study of economic decision-making by Canada 25.2 681.6 0.037 0.18
consumers, households, firms and government, and the way in South Africa 8.6 121.9 0.081 0.274
which these relate to the operation of markets. Its focus has been Chile 10.5 66.5 0.158 0.42
on areas such as supply and demand, on the organisation of
markets and on industry regulation. Peru 4.1 53.0 0.077 0.46
Macroeconomics, by contrast, is concerned with the Papua New 0.8 3.0 0.250 0.80
operations of national economies and the world economy. Its Guinea
focus has been on measures of economic performance such as Botswana 1.9 5.3 0.360 0.59
Gross Domestic Product, inflation, investment, saving, economic Namibia 1.4 3.5 0.200 0.62
growth, the balance of payments and the distribution of income
and wealth. It is concerned as well with the formulation of fiscal, Ghana 0.9 5.7 0.250 0.49
monetary and other areas of national economic policy to manage Zambia 0.7 3.3 0.200 0.74
these variables. Indonesia 13.0 144.7 0.090 0.29
There has also been strong interest in areas such as
Nigeria 6.7 37.1 0.180 1.00
international trade and finance, economic development, financial
markets and institutions, public finance, labour markets, Saudi Arabia 56.1 181.1 0.310 0.95
economic systems, urban and regional economics, natural
resource economics, environmental economics, economic
history, law and economics, and the history of economic thought.
Many economists make their careers by specialising in one of Minerals differ widely in their characteristics. The standard
these fields2. classification of metals, non-metals and energy minerals
provides one pointer to these differences. An appreciation of the
In a rather different way, there has also been a growing interest
in the economics of many major industries. Fields such as diversity of minerals produced and consumed is possible by
agricultural economics, transport economics, health economics, reviewing relevant web pages of the United States Geological
communication economics, tourism economics, cultural Survey or Natural Resources Canada. The list in Table 1.2
economics, and mineral economics also are now distinct (derived from United States Geological Survey web pages)
sub-disciplines. shows that there are at least 50 metals, 50 non-metals and seven
The study of these areas has emerged because of: or eight major energy minerals that are mined or drilled on a
regular basis around the world. They vary widely in value with
• the overall size of these industries; oil being worth several hundred billion dollars annually, while
• their importance to specific economies and regions; and some of the smaller minerals would be worth perhaps as little as
• different specific characteristics which make them worthy of US$ 10 million each year.
separate analysis. MacKenzie (1987, p 6) argues that the main special
characteristic of the minerals sector that justifies its study as a
The minerals sector currently accounts for around US$ 700 separate sub-branch of economics relates to the issue of
billion of world production. This is a little more than two per cent geological endowment. The implications of a fixed endowment
of the world’s estimated gross product. Perhaps more importantly, for economic analysis relate to patterns of optimal use, the
international minerals trade has consistently accounted for more optimal timing of this use, increasing scarcity and conservation.
than ten per cent of the value of world merchandise trade since He notes in particular that mineral deposits are:
1960. Mineral production and trade is of great significance in as
many as 50 nations, and it is the dominant industry in many • initially unknown (they must be discovered);
sub-national regions around the world. Some indication of this • fixed in size (they are non-renewable);
importance for selected economies can be seen in Table 1.1.
• variable in quality (they often must be extracted using new
A difference between minerals and many other commodities is technologies); and
that they are factor inputs rather than final consumer goods. With
one or two notable exceptions, manufacturers demand them • fixed in location (they may be discovered in remote locations
because of the particular attributes they possess – qualities such and need to be moved to intermediate and end-use markets).
as strength, ductility, heat conductivity, and resistance to An associated supply-side matter of interest is recycling. While
corrosion to produce final consumer and producer goods. most energy minerals can be consumed only once, metals and
some non-metals can be profitably recycled using old-scrap and
2. It can also be noted that the broader discipline of finance has become new-scrap sources. Recycling may also be more environmentally
an area of applied microeconomics in the past three decades. friendly.

2 Australian Mineral Economics

 CHAPTER 1: MINERAL ECONOMICS — AN INTRODUCTION

TABLE 1.2 4. they have unusually large local environmental, social and
A classification of mineral resources – metals, non-metals and economic impacts; and
energy. Source: United States Geological Survey (2006).
5. their national economic impact varies greatly over
Metals Non-metals Energy relatively short periods of time.
Aluminium Abrasives Black coal
Antimony Aggregates Brown coal THE FOCUS OF MINERAL ECONOMICS
Arsenic Bromine Crude oil While one can justify the study of mineral economics in terms of
Asbestos Cement LNG the rise of the economics discipline, the emergence of mineral
Bauxite and alumina Clays LPG economics has also been influenced by the development of
parallel sub-disciplines such as engineering economics. In their
Barite Corundum Uranium preface to a successful US text in the area, Riggs, Bedworth and
Beryllium Crushed stone Randhawa (1996, p xv) note that:
Bismuth Diamond The curriculums of most professional schools (of
Cadmium Dimension stone engineering) include a course in applied
Cesium Feldspar economics under such titles as engineering
economy, financial management, managerial
Chromium Fluorspar
economics and economic decision-making.
Cobalt Garnet
Copper Gemstones
These courses typically appear in the latter part of the
undergraduate curriculum. In mining schools, they were initially
Gallium Graphite often called mining economics. Their emphasis was typically on
Germanium Gypsum decision-making at the operational level, usually with a focus on
Gold Helium minimising or optimising costs in the context of investment
Indium Iodine
decisions. Students completing these courses often then expect
that subsequent study of mineral economics will largely be
Iron Lime focused on issues or project evaluation and related areas of
Lead Limestone applied financial analysis.
Lithium Mica While this emphasis from the operations side has been an
Magnesium Peat important influence on the development of mineral economics,
Schanz (1990) points to a broader emerging interest in the
Manganese Perlite
economics of the mineral industry in the United States in the
Mercury Phosphate rock early 1930s. The Brookings Institute commissioned lectures in
Molybdenum Potash the area in 1931 and faculty members at universities such as
Nickel Pumice
Penn State and Columbia began offering courses in the late
1930s. The origins of the formal study of mineral economics
Niobium Quartz crystal appear to have come from concerns over the implications of the
Platinum group metals (6) Salt fixed geological endowment for strategic mineral supply in the
Rare earths (14) Sand and gravel United States during the Cold War. In 1946 the College of
Mineral Industries at Penn State formed a separate small
Rhenium Sandstone
department to offer the first degrees in mineral economics.
Silver Scoria Several other mineral economics programs have emerged over
Tantalum Selenium the past half-century (and some of these have disappeared). As
Thallium Silica this volume is written there are six or seven active programs
spread around the world. They are at institutions such as the
Thorium Slate
Colorado School of Mines, Curtin University of Technology, the
Tin Sodium sulfate University of the Witwatersrand, Michigan Tech, the University
Titanium Sulfur of Chile, the Luleå University of Technology and the Pontificia
Vanadium Talc
Catholic University of Chile.
Post-professional programs in mineral economics tend to
Zinc Tungsten
contain a strong emphasis on financial analysis. They combine
Zirconium Vermiculite this with study of mainstream economic issues, which arise from
the special nature of mineral markets, and the other features that
the geological endowment constraint places on the study of the
Garnaut (1995) adds a further perspective on the special nature of
discipline. One view is that the key contribution of mineral
minerals when he describes five characteristics of mines that make
economics has been systematically to analyse the benefits and
them a special focus of government policy and administration.
costs at project level, for the firm and for society.
These are:
Many professionals, who take mineral economics courses, are
1. they can generate economic rent3; seeking to move into more senior managerial roles. It seems
2. they are often established most efficiently on a very large desirable therefore, that any comprehensive treatment of the area
scale; should address the strategic, operational and human resource
management issues that relate specifically to resource sector
3. their development is often highly capital intensive; companies, as well as providing a suitable overview of the legal
environment in which these firms operate. These elements relate
3. Chapter 13 later shows that this ‘is a surplus in excess of the minimum quite neatly to Galbraith’s broader definition of economics, with
profit required by shareholders in a company or firm to stay in its focus on economic theory, the corporation and decision-
business’. Mineral rents receive further attention also in Chapter 15. making.

Australian Mineral Economics 3

CHAPTER 1: MINERAL ECONOMICS — AN INTRODUCTION
It is instructive to complete this introductory discussion by
making one further important point. MacKenzie (1987, p 8)
identifies two main requirements for the practice of mineral
economics. They are:
• knowledge of the principles of economics and associated
analysis techniques; and
• understanding of the technical characteristics of the mineral
sector that are of significance from an economic viewpoint.
The focus of discussion in this chapter has been on the first of
these issues. However, the second point is also important. It is
often necessary to appreciate the technical issues relating to a
mining or energy project to apply economic and other principles
to its analysis. Business, law and economics graduates will find it
difficult to undertake the depth of analysis necessary to analyse
minerals sector issues unless they extend their technical
knowledge in areas such as geology, mining methods and
mineral processing.
A well-trained mineral economist will apply economic
principles, in combination with suitable technical knowledge, to
analyse resources available in a fixed endowment. He or she will
consider issues such as how to use minerals, when to use them,
how to mine them, when to recycle them and how to regulate
them.
SOME KEY QUESTIONS IN MINERAL
ECONOMICS
This short section is something of an aside. It seemed a good
idea to pose some of the questions that we are seeking to address
in this volume. The aim is to whet your appetite for the journey
ahead. Here they are!
Does an abundance of mineral resources make a country rich?
What effects do mineral-based resource booms have on
different economies?
What factors influence the discovery and exploitation of
minerals around the world?
What did the discovery of gold do to the Australian economy?
Why has the resources sector been important to economies
such as Australia, Canada and Chile in the recent past?
What factors determine the contribution of mineral production
to sustainable economic wellbeing?
What influence has greater environmental regulation had on
the supply of minerals?
What forces have been driving change in mining’s interaction
with local communities?
How important is international trade in minerals and energy?
What role has major changes in transport costs played in
international minerals trade?
How does recent growth in mineral and energy trade
compare with growth in other areas of international trade?
What are the sources of competitive advantage of the
Australian minerals sector?
What are the key factors that influence the demand for
different minerals?
How important are joint production issues in the analysis of
mineral supply?
How has recycling affected the supply of major metals in
the recent past?
4 Australian Mineral Economics
THE STRUCTURE OF THIS VOLUME
In compiling this monograph, our aim is to provide a balanced
and up to date view of the approaches and techniques which
mineral economists use to appreciate the resources sector. While
the bias of this volume is towards the Australian mineral and
energy sector, the discussion often takes a broader perspective.
We live in a ‘global village’ and if this volume is to provide value
to its readers, it must be internationally relevant.
The 17 chapters that follow this introduction are organised in
four main sections:
• Minerals and the World Economy (three chapters);
• Minerals: Consumption, Production and Markets (four chapters);
• Mineral Finance and Investment (four chapters); and
• Minerals and Public Policy (six chapters).
Philip Maxwell has played the coordinating role with the first,
second and fourth sections. Pietro Guj is responsible for the
Mineral Finance and Investment section. Each of us contributes
on an ongoing basis to the Graduate Coursework program in
Mineral Economics in the Western Australian School of Mines.
One of the features that has assisted the quality of our program
offerings over the past decade has been the contributions from
colleagues from other institutions, both in Australia and
overseas. It is particularly appropriate, therefore, that several of
these visiting faculty, together with other selected colleagues, are
also contributing to this volume. Others have acted as reviewers.
Their insights enhance the quality of the pages ahead. We thank
them for their contributions.
REFERENCES
Galbraith, J K, 1978. The New Industrial State, third revised edition,
(Houghton Mifflin: Boston).
Garnaut, R, 1995. Dilemmas of governance, in Mining and Mineral
Resource Policy in Asia-Pacific: Prospects for the 21st Century (eds:
D Denoon, C Ballard, G Banks and P Hancock) pp 61-66 (Australian
National University: Canberra).
Heilbroner, R, 1972. The Worldly Philosophers, fourth edition (Simon
and Schuster: New York).
MacKenzie, B, 1987. Mineral Economics: Decision-Making Methods in
the Mineral Industry (Australian Mineral Foundation: Adelaide).
Marshall, A, 1890. The Principles of Economics.
Riggs, J L, Bedworth, D B and Ranhawa, S U, 1996. Engineering
Economics, fourth edition (McGraw-Hill: New York).
Robbins, L, 1932. An Essay on the Nature and Significance of Economic
Science (Macmillan: London).
Schanz, J J Jr, 1990. Mineral economics and mineral economists –
Origins of the species, Working Paper 90-13, Department of Mineral
Economics, Colorado School of Mines, 41 p.
Smith, A, 1976 [1776]. An Enquiry into the Nature and Causes of the
Wealth of Nations (eds: R H Campbell, A S Skinner and W B Todd)
(Oxford University Press: Oxford).
United States Geological Survey, 2006. Commodity statistics and
information [online]. Available from: <http://minerals.usgs.gov/
minerals/pubs/commodity>. Date accessed: 8 May 2006.
Waud, R N, Maxwell, P, Hocking, A, Bonnici, J and Ward, I, 1996.
Economics, third Australian edition (Longman: Melbourne).
World Bank, 2004. World Development Indicators (Oxford University
Press: New York).

Minerals, Growth and Development
Philip Maxwell
Some Foundations – Mineral Exploitation, Production, Distribution, Consumption, Trade and
Related Economic Concepts
Economic Growth and Development
Periods of History and Minerals
Economic Development and Mineral Resources – The Traditional View
The Australian Experience
Complicating Factors with Mineral Production and Consumption
Appendix – A Classification of Developed and Developing Nations
SOME FOUNDATIONS – MINERAL EXPLOITATION,
PRODUCTION, DISTRIBUTION, CONSUMPTION,
TRADE AND RELATED ECONOMIC CONCEPTS
Several processes always occurring within any economy
determine the economic wellbeing of its citizens. They include
production, distribution, consumption and trade. The focus of
this volume is how minerals and energy impinge on these
processes.
It is typical, initially at least, to think of the ways in which
people use minerals and energy in the process of producing goods
and services. The distribution of the proceeds of resource wealth
and the consumption of mineral and energy resources are very
important as well. Furthermore, the sale and purchase of minerals
and energy through interregional and international trade plays an
important role in increasing people’s welfare.
Let us begin by taking a production view of things. Over any
given period, what an individual, firm, region, nation or the
world produces in terms of a production function in which the
output generated is a function of the economic resources used as
inputs. Economists have typically denoted these resources as
land, labour and capital. The state of technology may also be
added as an additional factor but in the short term at least this
may be reflected in the nature of the capital stock and the quality
of the labour force. More recently it has also become common to
include the environment (or environmental services) among this
group of inputs.
1. It has become increasingly common practice to identify land as
natural capital, labour as human capital and capital as physical
capital.
2. This criticism continues to apply to the activities of most small-scale
and artisanal miners in developing nations.
Australian Mineral Economics
CHAPTER 2
Hence it may be hypothesised that:
Economic output = f (Land, Labour, Capital, Environment)
But what do economists mean by land, labour and capital?
Land refers to all of the natural resources used in production. As
well as the land itself it includes water, forests, fisheries, oil, gas
and mineral deposits. Labour refers to the skills and capabilities
used by humans in the production process. Capital describes all
of the manufactured aids used in the process of production1.
The environment reflects the quality of the natural world
around us. It is responsible for quality of the air that we breathe,
the water that we drink and the way that we utilise it affects the
food that we eat and the materials that we use to build shelter for
ourselves. The services that the environment provides are an
input to production. It is also a ‘sink’ for our wastes and if this
aspect is overused, the environment can adversely affect our
ability to produce.
Critics might argue that most mining and oil companies
neglected their surrounding environment until quite recently2.
Companies did so because their main focus was on profits and
dividends to shareholders, and governments did not actively
regulate pollution. They were not alone in their practices. Many
manufacturing firms did little to treat wastes, discharging them
into the nearby atmosphere, or into rivers, lakes or the ocean with
minimal treatment. Also, in many parts of Australia, past farming
practices have resulted in erosion and reduced soil fertility.
The following statement by McDivitt and Jeffrey (1976, p 16)
reflects an interesting additional economic perspective about the
impact of mining on production:
mineral development can contribute to the three
major factors of production – land, through
bringing into action otherwise dormant resources
in the country; capital, both through attracting
7
CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT
outside investment capital to the country and
through providing new money some of which can
be used for local investment; and labor, through
upgrading local skills and implanting concepts of
entrepreneurship.
That is, mining uses machines, labour, and ore to produce
metals that produce further capital (buildings, bridges). Through
the process, worker skills are upgraded, enhancing the labour
pool for mining’s own use or for use in other sectors. If they were
rewriting this passage today, the two authors may also have
included a reference to environmental quality issues.
In any economy, the issue of distribution is also important –
the way in which different individuals or groups share
production. Issues relating to the fairness or equity in the
distribution of income and wealth generate controversy. This
happens within families, regions and also between nations on the
world stage. Governments use the proceeds of taxation and
royalty collection to redistribute this income and wealth.
The discovery and exploitation of minerals often brings major
new activity to mining regions. Issues quickly arise as to how
much of the windfall should be retained by local residents, how
much distributed to the investors (often from other places) who
have taken risks and incurred large past expenditures to develop
new oil wells or mines, and how much redistributed by
government to citizens in other regions or states. These
controversies are often the source of continuing disquiet. Where
resolved in a satisfactory fashion, major new mineral and energy
production has the potential to be shared widely for the benefit of
many people in the state where a mining region is located, and in
the nation more generally3.
Hence one might argue that the great mineral wealth of the
Pilbara, Eastern Goldfields and other mining regions of Western
Australia have been distributed effectively over more than a
century. It has enhanced the income and general fortunes of the
average citizen of the mining regions. A large royalty stream,
together with payroll tax receipts, has assisted the finances of the
Western Australian government. Greater individual and company
income taxes, as well as resource rent royalties, have also
contributed to the welfare of Australians more generally.
Even without the hand of government to redistribute income
and wealth through the fiscal system, many past mineral
discoveries have brought a more even distribution of income.
This was the case with the Victorian, New South Wales and
Western Australian gold rushes in the 19th century. Blainey
(2003, p 62) notes that:
Gold checked, and for a time, reversed
Australia’s tendency to become a land that
favoured the big man. Whereas Australia’s first
natural asset, the sheeplands, was grasped by a
few thousand men, its second rich natural asset,
the goldlands was divided among hundreds of
thousands of men.
3. An important associated point here relates to the intertemporal flow
of resources. A mine that is generating lots of production/profit in
2005 may not be generating enough to pay off the debt incurred in
building the mine. Yet the profits are often seen as a windfall.
4. Elements of this argument apply widely to labour-intensive
small-scale mining activities in developing nations.
5. Technology will of course make it more possible to access lower
grade deposits over time.
6. Vertical integration describes a situation in which ‘a firm participates
in more than one successive stage of the production or distribution of
goods and services’.
8 Australian Mineral Economics
Where mineral windfalls involve labour-intensive mining
activity there is increased opportunity to share income and
wealth more equally4. But as minerals then become less
amenable to labour-intensive mining and require greater amounts
of capital, there is potentially the reverse tendency for the
distribution of income and wealth to become more unequal.
A continuing issue regarding our future concerns the way in
which production and consumption relate to one another.
Consumption involves individuals and households (the private
sector) and also government using up goods and services.
If a society consumes less than it produces (ie spends less than
its income) in any given time period, its members (both the
private and public sector) can save the residual and invest it to
ensure production continuing in the future. Saving and
investment are important additional concepts in the economist’s
lexicon. Saving refers to the amount generated from abstaining
from consumption in any given period, while investment is
spending on capital formation, both physical and human.
New investment that increases a nation’s or region’s physical
and human capital typically provides the basis for further
economic growth and development. If citizens consume what
they produce, or more than they produce by borrowing against
future expected production, their capital stock will fall and so
will production, if other things are equal. It is typical to be
impressed by ‘economic miracle’ nations whose strong growth
and development is attributable to saving, followed by wise
investment in new physical and human capital. The economic
performance of Japan, Korea, Taiwan, Singapore, Hong Kong
and now China in the latter part of the 20th century have drawn
great praise from most commentators.
Where nations have large mineral and energy resource
endowments, much of which may have only recently been
discovered, there also seems considerable potential to invest the
profits from its exploitation. Such endowments form part of a
natural capital base. Some natural capital is renewable, while
some is not. It is normal to think of agricultural land, forests,
fisheries and solar, wind and tidal energy as renewable
resources, and to classify minerals and many other energy
sources as non-renewable resources. Despite their finite nature,
and as noted earlier, it is possible to recycle many minerals in a
financially viable way.
If minerals are produced, and consumed, and they cannot be
recycled, their stock will decline5. How the citizens of a country or
region allocate the proceeds of mineral exploitation to current
consumption and investment is an issue that has been of interest to
many people. Such debate is typically heard in discussions about
minerals and sustainable development.
The final key concept in this section is trade. Trade takes
place because it makes individuals, companies and nations better
off. By specialising in the things they can do best, these groups
can exchange part of their production for a variety of goods and
services that will enable them to reach a higher standard of living
than without trade. Trade takes place within regions, between
regions and between nations. Trade in minerals and energy is
important. The nature and location of mineral deposits means
that not all nations or regions can be self-sufficient in minerals,
even if they want to be. With the exception of mineral production
by firms that are vertically integrated6, most minerals and energy
produced is traded either domestically or internationally.
As will be discussed later, exports of minerals and energy play
an important part in increasing the economic and social welfare
of perhaps one quarter of all nations. Their importance to
Australia was particularly significant from the early 1840s until
the beginning of World War I. Though subsiding dramatically
after 1914, mineral export trade rose again dramatically from the
1960s onwards. Sustained international competitiveness in many
sectors of the industry has underpinned Australia’s strong
economic performance in the last part of the 20th century and at
the beginning of the new millennium.
 CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

TABLE 2.1
Key production and growth indicators for selected economies. (Source: World Bank, 2005.)
Nation GDP in 2001 GDP per capita in 2001 GDP per capita at PPP in Real GDP growth
(US$ billion) (US$) 2001 (US$) 1990 - 2001 (per cent)
Major developed economies
United States of America 10 416 35 060 35 060 3.7
Japan 3978 33 550 24 076 2.3
Germany 1976 22 670 24 288 2.4
United Kingdom 1552 25 250 24 467 3.4
France 1409 22 010 22 716 2.0
Italy 1181 20 397 25 809 1.8
Korea 448 9471 15 087 5.6
Major developing economies
China 1237 940 4177 8.9
India 515 480 2929 7.9
Russia 346 2390 9385 -0.2
Indonesia 172 710 2900 5.6
Major mineral exporters
Canada 715 22 300 26 992 2.9
Brazil 452 2850 6569 2.9
Australia 410 19 740 24 451 4.3
South Africa 104 2600 10 067 2.7
Chile 64 4260 8206 6.2
Peru 57 2050 4634 3.7
Developing mineral economies
Papua New Guinea 2.8 530 2297 1.4
Ghana 6 270 2037 5.5
Tanzania 9.4 280 1321 3.0
Botswana 5.2 2980 7309 8.1
Zambia 3.7 310 752 2.8
Dem Rep of Congo 5.7 90 707 -10.9
Major oil producers
Saudi Arabia 187 8460 13 267
Venezuela 108 1710 6025 3.5
Iran 109 1680 5940 3.4
Nigeria 37 285 784 2.9

ECONOMIC GROWTH AND DEVELOPMENT
When commentators discuss the economic growth of a nation, a
region, or the world, they usually are referring to the percentage
rate of growth in total production over a given period such as a
year (or a quarter).
On some occasions, however, they may mean:
• the percentage rate of growth in per capita production of the
average citizen over a given time period; and
• more recently, the rate of growth of productivity, or output
per worker.
Following the widespread adoption and use of national
accounting frameworks throughout the world since 1950, it has
become standard practice to measure economic growth by
7. The GDP measure differs conceptually from Gross National Product,
which refers to the estimated value of final goods and services produced
in a given period by a country’s citizens. International agencies such as
the World Bank have recently commenced using another measure
(Gross National Income (GNI)) in making international comparisons of
economic size and growth between nations.
computing percentage changes in real Gross Domestic Product –
commonly known as GDP. The term ‘real’ is used to indicate that
the measure has been adjusted for changes in the rate of inflation.
Gross Domestic Product is a measure of the market value of final
goods and services produced in an economy during a given period7.
Each nation’s central statistical agency typically has the role to
compute official estimates of GDP. In the case of Australia, this
organisation is the Australian Bureau of Statistics. Australia’s
officially estimated GDP in the 2002-03 financial year was
around A$ 735 billion (or US$ 450 billion). This meant that GDP
per capita for each of Australia’s 19.7 million inhabitants was a
little more than A$ 37 000. Australia’s rate of real GDP growth
during this period was 3.8 per cent.
Some comparisons between the level of Australia’s GDP in
2001 and those of selected other nations, together with actual
GDP per capita, and GDP per capita at Purchasing Power
Parity (PPP) appear in Table 2.1.
The PPP adjustment in GDP per capita allows for cost of
living differences. The benchmark for the PPP measure is the
cost of living in the USA. GDP per capita in the US was
US$ 35 060 in 2001. Its GDP per capita at PPP was, of course,
also US$ 35 060.

Australian Mineral Economics 9

CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT
Compare this with the situation in Japan. Over the past two
decades, most would judge that the cost of living in Japan has
been high. While GDP per capita in Japan, at US$ 33 550, was
close to that in the US, that nation’s GDP per capita at PPP was
only US$ 24 076. The cost of living in the United States was
about 30 per cent less than in Japan.
Think now about the average Australian, whose estimated
GDP per capita in 2002 was US$ 19 740. The purchasing power
of an Australian income earner was almost 24 per cent higher
than his or her counterpart in the United States. Australia’s
estimated GDP per capita at PPP in 2002 was US$ 24 451.
These estimates are important for mining companies and
consultants in estimating the relative average living standards of
citizens, and potential operating costs, in nations in which they
may wish to invest or otherwise do business. In Chile, for
example, per capita GDP was only US$ 4206 in 2002. But,
because the cost of living was only about a half of that in the
United States, estimated GDP per capita at PPP was US$ 8206,
almost double this amount.
The GDP measure has several notable limitations. Importantly
it does not include adjustments for capital consumption,
depreciation of natural capital, or environmental degradation. It
fails to include estimates of the value of non-market goods such
as work at home. Hence the contributions to production of
women and men who devote their lives to being homemakers and
raising families are not included. Also excluded is the work of
volunteers who contribute generously to the functioning of many
community organisations. In a 1987 study, the Australian Bureau
of Statistics estimated that Australians devoted just over 250
million hours each week to paid work, and a further 303 million
hours to unpaid work.
Notwithstanding the significant contributions to overall
production of these latter groups in a country such as Australia,
the size of these latter parts of the informal economy are of
considerably greater relative importance in developing nations.
Hence, even adjusting for Purchasing Power Parity, it is still
likely that any comparison of living standards using GDP per
capita at PPP between an affluent developed nation, such as
Australia, and a poor developing mineral economy in Africa will
overstate the difference between them. While it is clear,
therefore, that the average citizen of a nation such as Tanzania is
very poor, his or her production will in reality exceed the
estimate of $1321 in Table 2.1 by a higher percentage than it
does for the average Australian citizen. GDP per capita at
Purchasing Power Parity comparisons between nations are at best
only an approximate indicator of differences.
These limitations have stimulated a number of alternative
approaches and adjustments to reflect a country’s economic size
and stage of development in a more effective manner. But this
statement itself begs the question of what development really
means.
Todaro (1989, pp 86-87) points to traditional views that
development or economic development takes place over an
extended period (of say ten years or more) when an economy:
8. As this manuscript is written, the Human Development Report is
readily available in downloadable form from the UNDP web site:
http://www.undp.org.
9. Through its promotion of the Millennium Development Goals the
United Nations has focused attention over the past five years on ‘an
expanded vision of development… that vigorously promoted human
development as the key to sustaining social and economic progress’.
10. Norway and Sweden (not listed in Table 2.2) were the top ranked
nations in 2000 with HDI values of 0.942 and 0.941 respectively.
11. It is important to acknowledge that because the goalposts are
renormed every year that intertemporal comparisons of HDI values
should be interpreted with caution.
10
• is able, following a period of mediocre economic performance,
to bring about annual rates of growth exceeding five per cent; or
• generates consistent growth in its real GDP per capita.
Hence, according to the estimates reported in Table 2.1, it may
be argued that between 1990 and 2001 nations such as South
Korea, China, India, Indonesia, as well as the two mineral rich
nations of Botswana and Chile experienced economic
development.
But the Todaro view also seems implicitly to assume that the
structure of such an economy will change, with the emergence of
major new and competitive industry sectors (eg manufacturing,
services, etc). The achievements over a longer period of Japan
and the Asian Tigers and China, which have transformed their
economies, are examples of significant economic development
taking place. Historically, it would also seem that nations such as
the United States, Britain, Germany, France, Canada and
Australia have experienced economic development surges in this
way.
During the 1970s, a broader view emerged concerning the
dimensions of the concept of economic development. Writers
began to consider economic development in terms of reducing
poverty, income inequality and unemployment when an economy
was experiencing consistently strong real GDP growth over an
extended period.
In his extended definition, Todaro (1989, p 88) argues that:
Development must… be conceived as a
multi-dimensional process involving major
changes in social structures, popular attitudes and
national institutions, as well as the acceleration of
economic growth, the reduction of inequality, and
the eradication of absolute poverty.
Associated with this interest in a broader definition of
economic development, several economists have proposed the
use of broader socioeconomic indicators to measure
development. These began in the United Nations in the late
1960s. One of the notable measures has been Morris’s Physical
Quality of Life Index (based on life expectancy at age one, infant
mortality and literacy). Following in this tradition, the United
Nations Development Programme (UNDP) publishes its Human
Development Index (HDI) in its annual Human Development
Report8. The HDI measure is based equally on life expectancy,
education levels and the average standard of living (UNDP,
2003, p 340). The UNDP classifies countries as follows:
Level of human development HDI value
High 0.8 or above
Medium Between 0.5 and 0.8
Low Less than 0.5
Estimates of the HDI for 2000 appear in Table 2.2 for the same
selection of countries as in Table 2.1. The UNDP ranked 173
nations in its 2000 list. It classified 55 nations as exhibiting high
human development, 83 with medium human development and 37
with low human development9. A complementary classification of
developed and developing nations also appears in the Appendix of
this chapter.
Most of the major developed economies (with Canada and
Australia also on this list) have Human Development Index
values greater than 0.910. These values had increased by
approximately 0.1 between 1975 and 2000. Among the four
major developing nations, China and Russia had Human
Development Index levels above 0.7. While HDI levels had
consistently risen in China since 1975, they had fallen in Russia
from 0.824 in 1990 to 0.781 a decade later. Both India and
Indonesia experienced rises of around 200 points in their HDI
levels between 1975 and 200011.
Australian Mineral Economics
 CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

TABLE 2.2
Estimates of human development indices for selected economies in 2000. (Source: United Nations Development Programme, 2003.)
Nation Life expectancy Education GDP at PPP HDI GDP per capita
minus HDI rank
Major developed economies
United States of America 0.87 0.98 0.97 0.939 -4
Japan 0.93 0.93 0.93 0.933 2
Germany 0.88 0.97 0.92 0.925 -2
United Kingdom 0.88 0.99 0.91 0.928 7
France 0.89 0.97 0.92 0.928 6
Italy 0.89 0.94 0.91 0.913 -1
Korea 0.83 0.95 0.86 0.882 1
Major developing economies
China 0.76 0.80 0.61 0.726 0
India 0.64 0.57 0.53 0.577 -1
Russia 0.68 0.92 0.74 0.781 -2
Indonesia 0.69 0.79 0.57 0.684 1
Major mineral exporters
Canada 0.90 0.98 0.94 0.940 4
Brazil 0.71 0.83 0.72 0.757 -13
Australia 0.90 0.99 0.93 0.939 7
South Africa 0.45 0.88 0.76 0.695 -56
Chile 0.84 0.90 0.76 0.831 12
Peru 0.73 0.87 0.65 0.747 6
Developing mineral economies
Papua New Guinea 0.53 0.55 0.52 0.535 -9
Ghana 0.53 0.62 0.50 0.548 1
Tanzania 0.43 0.61 0.28 0.440 21
Botswana 0.25 0.75 0.71 0.572 -62
Zambia 0.27 0.68 0.34 0.433 12
Dem Rep of Congo 0.44 0.51 0.34 0.431 11
Major oil producers
Saudi Arabia 0.78 0.71 0.79 0.759 -26
Venezuela 0.80 0.83 0.68 0.770 10
Iran 0.73 0.75 0.68 0.721 -22
Nigeria 0.44 0.58 0.37 0.462 9

Among the somewhat diverse major mineral exporting country
group, all except South Africa had experienced continuing
increases in their HDI levels. While rising from 0.714 in 1990 to
0.724 in 1995, South Africa’s level dropped to 0.695 by 2000.
Perusal of Table 2.2 suggests that the low value of 0.45 for the
life expectancy component of the HDI was largely responsible
for this. There were similarly low levels for other African
mineral economies such as Botswana, Zambia, Tanzania and the
Democratic Republic of the Congo. This is a reflection of their
health crises arising from the HIV/AIDS epidemic.
The final column of Table 2.2 provides a summary analytical
tool in comparing perceived development as reflected in HDI
ranking, with the narrower production-based GDP per capita at
Purchasing Power Parity. Positive entries indicate that the
GDP-based measure may understate a country’s stage of
development. Nations such as the United Kingdom, France,
Australia, Chile and Venezuela might all be somewhat more
developed according to this metric. Brazil, South Africa,
Botswana, Papua New Guinea, Saudi Arabia and Iran are
apparently less developed. While this summary measure provides
a novel development indicator, the impact of the health crisis in
sub-Saharan Africa seems to undermine its value for anything
more than a first pass appraisal by a mining company of the stage
of development of any potential new investment destination.
Other things being equal, it should be more attractive to invest
in a more developed nation, but making a judgment about
development should involve assessing several other issues.
Consistent with the Todaro definition above, such things as social
and institutional stability and honesty, income and wealth
distribution trends, and poverty levels interact with the status of
mineral policy and the extent of a country’s mineral endowment
in doing this in an effective and professional way.
PERIODS OF HISTORY AND MINERALS
Minerals and energy have had a major role in the history of the
world. This is apparent simply by noting that so many periods
have been characterised by material or energy names. Reflecting
the role of changing technology (apparent in the production
function) the use of key minerals as a principal ingredient of
tools, or power, in periods bearing their names brought
improvement in terms of human well-being, as measured by
population growth and other indicators.

Australian Mineral Economics 11

CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT
TABLE 2.3
Different periods in history. (Source: Derived from Wilson, 1994.)
Period Dates
Homo Erectus 500 000 years ago
Homo Sapiens 200 000 years ago
Stone Age 30 000 to 4000 BC
Neolithic (New Stone Age) SW Asia 9000 to 6000 BC
Europe to 4000 BC
Chalcolithic (copper-stone) period 4000 to 3000 BC
Copper Age Began 3000 BC
Bronze Age Began 2500 BC
Iron Age Began 1000 BC
Coal Age Began AD 1600
Industrial Revolution (based on AD 1750 to 1850
coal, iron and steam)
Oil Age Began AD 1875
Atomic Age Began AD 1945
Information Age Began AD 1960
This shows up clearly in Table 2.3, a summary table adapted
from Wilson (1994). Wilson (1994, p xiii) also argues that:
The history of metals is the history of civilisation.
The two are inseparable; each depends on the
other for its development; when one stumbles the
other falters. Ever since Neolithic man learned the
secret of winning metals from ore-bearing rock,
metals have dominated the world’s political,
social and economic evolution. For 5000 years
they have been the major factor in the flowering of
a people’s culture, the key to their industrial
power and their influence in world affairs.
There seems much to this argument, though modern oil and
gas producers would also associate themselves with these views.
A brief review of ancient history illustrates how members of
the prominent civilisations effectively used new technologies in
processing metals such as copper, iron, gold, silver and tin as a
basis for enhancing both the quality of life of their citizens, as
well as their military strength. The emphasis on the latter area
seems to have been of central importance in the domination of
surrounding populations. This applied in varying ways to the
Sumerian, Babylonian, Assyrian, Persian, Greek, Carthaginian,
Roman and Chinese civilisations. With the fall of the Roman
Empire around 450 AD, the use of metals dwindled as the world
of Europe and the Middle East descended into the ‘Dark Ages’
period.
Though new uses of minerals and energy began slowly
emerging after 1500, it was the emergence of the Industrial
Revolution in the United Kingdom from about 1750 that
heralded the widespread modern uses on minerals and energy.
The emergence of heavy industry, the widespread use of coal and
more recently oil and gas as its major energy sources, and the
rise of materials such as steel, aluminium and a range of more
exotic metals, have all been part of this picture. The Industrial
Revolution has led to consumer societies in which minerals and
energy are used in ways and at levels that were previously
unimaginable. Associated with this have been major
technological advances in exploration, mining and particularly
mineral processing. Advances in transport technology have also
12. Several economic historians have written authoritatively about the
topic. Notable among them have been Blainey (1966, 2003), Sinclair
(1976) and Shaw (1966).
12
created a global minerals economy, and as will be seen in the
next chapter, have hastened the economic development of nations
such as Australia in a dramatic way.
ECONOMIC DEVELOPMENT AND MINERAL
RESOURCES – THE TRADITIONAL VIEW
A generally accepted view is that the presence of minerals should
assist the economic fortunes of a nation or region. The greater
the quantity of reserves available, up to some point, the more
economic growth should be generated and conversely, as reserves
are used up, economic growth will be constrained. The
discussion then moves to sustainability issues. Wise investment
of the proceeds of mineral exploitation should ensure a different
but potentially sustainable economy after the lode has run out.
Tilton (1992, p 1) notes that:
…the returns from mineral exploitation can be
used to build airports and highways, stores and
factories, schools and hospitals, and homes and
parks. They can enhance political stability by
addressing regional and tribal grievances and in
various ways bolster economic growth.
Mining and mineral processing can also
generate jobs, provide opportunities for the
development of domestic skills, encourage the
creation of associated industries, and provide
other beneficial side effects or linkages for the
local economy.
He goes on to observe that:
History documents that mineral resources can
indeed facilitate economic development. The
Industrial Revolution began in England and
quickly spread to Germany and the United States
partly because these countries were well
endowed with coal and other natural resources.
Saudi Arabia and other Middle East
oil-producing countries are more recent
examples of the positive role mineral wealth can
have in economic development.
A major mineral windfall has the potential, if properly
managed, to stimulate economic growth, raise incomes and allow
investment in human and physical capital, which will ensure a
nation’s longer term economic and social success.
THE AUSTRALIAN EXPERIENCE
Australia’s experience with minerals and energy seems to fit in
well with this traditional view. The impact of major mineral
discoveries, and their subsequent exploitation, on Australia’s
economic performance during more than two centuries of
European settlement is an interesting case study. Perceived in
terms of the perspective of economic production and the factors
in the production function, described in the McDivitt and Jeffrey
quotation at the beginning of this chapter, the discovery and
exploitation of minerals transformed Australia. It moved from
undeveloped to developed status over a relatively short period of
time.12 The further development of the resources sector
underpinned development of the Australian economy for much
of the second half of the 20th century. This contribution is set to
continue in the 21st century.
The major impact of mineral development did not emerge until
the 1840s, some 50 years after European settlement. The
discovery of copper in South Australia provided a strong
stimulus for the fledgling new colony there. But it was the gold
rushes in New South Wales and Victoria, only a decade later, that
dramatically transformed the Australian colonies from struggling
Australian Mineral Economics
 CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

TABLE 2.4
Mining and Australian population growth 1788 - 2001.
Year Total population (M)† M/F Main event in preceding period
1788 0.001 na Convict settlement
1800 0.005 2.63 Convict settlement
1820 0.034 2.44 Dominance of whaling, emergence of agriculture
1840 0.190 2.02 Decline of whaling, agriculture strong, new colonies (Victoria, South Australia, Western Australia)
1850 0.405 1.43 New colonies emerge, Irish famine, copper mines in South Australia
1860 1.146 1.40 Gold rushes (Bathurst, Ballarat, Bendigo, etc)
1870 1.648 1.21 Mining strong, emergence of railways, faster ships
1880 2.231 1.17 Continuation of above trends, emergence of Tasmanian mines, telegraph service
1890 3.151 1.16 Broken Hill rush, new gold finds, railway boom
1900 3.765 1.11 Major national recession, bank failures, Western Australia gold rush
1911 4.455 1.08 Federation, continued strength of mining
1921 5.435 1.03 First World War, copper boom
1933 6.629 1.03 Stock boom of 1920s, decline of mining towns, beginning of Depression.
1947 7.579 1.004 Effects of Depression, Second World War
1954 8.986 1.032 Post war boom, major new migration, promotion of manufacturing, uranium mines
1961 10.548 1.022 Strong economic growth, migration, manufacturing, major bauxite finds
1971 13.067 1.022 Continuation of above trends, new finds of iron ore, off-shore petroleum, nickel, coal
1981 14.932 1.005 Mining boom, stagflation, major rises in oil prices
1991 17.085 0.99 Deep recessions at beginning and end of decade, boom in middle, strong performance of mining, gold,
iron ore, coal, nickel, copper, etc
2001 19.5 0.975 Mining retains strong role with new discoveries continuing, Australian mining companies invest offshore

† Aboriginal population not included until 1971.

economic backwaters into much more desirable migration and
investment destinations. Some of the factors that held back the
discovery and exploitation of minerals in Australia were poor
roads, the lack of a railway system, unnavigable rivers and
distance from major markets.
Yet it was an unlikely and short-lived geographical advantage
– the proximity of ports like Sydney to California – that acted as
a catalyst for the Australian gold rushes. The discovery of gold
near San Francisco in 1848 led to the California gold rushes.
Although more than 10 000 km away on the other side of the
Pacific, the ten-week journey by ship from Sydney to San
Francisco was less than the 13-week journey around Cape Horn
from New York13. For a brief period Sydney became a significant
supply port for California. The Australians, who flocked across
the Pacific to join the rush, noticed the similarity of the terrain
with that in New South Wales. Returning to Sydney in early
1851, the entrepreneurial Edward Hargraves travelled to Hill End
where he showed local shepherds how to search for gold. They
soon discovered the yellow metal and on 3 April, Hargraves
announced to the Colonial Secretary in Sydney that he had
discovered gold.
The following quote by Shaw (1966, p 65) captures the
atmosphere in a colourful way:
On 3 April 1851, occurred an event which
radically changed the character of the Australian
colonies and tremendously hastened their
development. Edward Hammond Hargreaves
officially notified the Colonial Secretary of New
South Wales that he had discovered gold near
Bathurst.
13. There were no roads or railways across the United States at that time.
The Panama Canal was not completed until several decades later.
It was a memorable day. Its effects were
tremendous. There was an immediate rush to
New South Wales from the other colonies; to stop
this, a committee of Victorian businessmen on
9 June offered a reward of £200 for the discovery
of gold within 200 miles of Melbourne. It was
claimed next day. By the end of the year (1851)
rich fields near Ballarat and Bendigo and other
minor discoveries made Victoria, not New South
Wales, the magnet for the diggers.
The summary information in Table 2.4 provides some insight
into the effect of major mining discoveries and subsequent
mineral exploitation on Australia’s population growth. This
impact has been associated with sustained economic growth and
associated economic development.
Even though the British government established six colonies (in
what were to become Australia’s six states at Federation) during
the first 50 years of European settlement, the European population
grew slowly until 1840, when it stood at 190 000. This growth
related particularly to Australia’s status as a convict destination,
the rise and fall of whaling and the development of agriculture.
Even though the population more than doubled to 405 000 by
1850, partly due to the stimulus of the discovery of copper in
South Australia, it was gold that brought dramatic change.
Sinclair (1976, p 79) notes:
…the discovery of alluvial gold must be regarded
as a major discontinuity. The significance of this
for the course of Australian economic
development was heightened by the rapidity with
which gold was extracted from the ground.
Australia became the world’s leading gold producer as
production rose from zero in 1851 to more than 90 tonnes in 1856,
then declined gradually around 50 tonnes per annum in 1865.

Australian Mineral Economics 13

CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

14
13.2
12.8

12

10
8.7

6.2
(%)

6 5.5
4.9 5.1

3.8 3.8 3.7

4 3.4 3.3
3.2

2.0
2 1.6

0.4
0
s

0s

0s

0s

s
0s
70

80

90
30

40

50

60

40

50

60

70

80

90
0

3
18

18

18

18

18

18

18

19

19

19

19

19

19
19

19

19

19
-2

FIG 2.1 - Estimated percentage average real GDP growth in the Australian economy on a decade by decade basis – 1830 to 2000.

Blainey (2003, p 62) notes:
Possibly no other country in the world has been
so quickly transformed by metals; the normal
growth and achievement of several decades were
crammed into one. Australia ceased to be a land
of exile in British eyes and became a respectable
field of migration and [beginning with
capital-intensive underground mining in 1886]
investment… The swift growth of population
widened the market for Australian manufactures
and foodstuffs. It stimulated farms and factories
and workshops and cities. Gold drew population
into the interior and attracted railways from the
ports. Bendigo and Ballarat in 1862 got the
continent’s first upcountry railways, and cheap
transport stimulated farming…
This shows up in an interesting way in the estimates of average
annual real GDP growth, and GDP per capita growth, that appear
respectively in Figures 2.1 and 2.2. The Australian government
began producing the national accounts in a formal way during
the 1950s. The earlier estimates are derived from Butlin (1962)
and McLean (2004). They cover ten-year periods and hence do
not reflect considerable annual variations in the rate of growth.
In addition to stimulating the development of key industry
sectors such as agriculture, manufacturing, construction and
transport, the gold rushes of the 1850s inspired other major
mineral discoveries. These new finds included gold in many
areas of Queensland from the late 1860s, tin in northern New
South Wales during the 1870s, copper, gold and tin in Tasmania
between the 1870s and 1890s, gold in the Northern Territory in
the 1870s, and gold in Western Australia from the early 1880s.
By 1900, in the wake of the WA gold rushes, gold production had
risen to close to 100 tonnes per annum.
One recently used criterion (by Davis (1995) and others) is
that a country has a strong mineral economy if the ratio of the
value added by its mineral production to total GDP exceeds eight
per cent. The Australian colonies satisfied this measure during
the period between 1851 and 1914.
Not only did Australia’s Gross Domestic Product increase
dramatically during the 1850s. It grew strongly during every
succeeding decade (except the 1890s) until the beginning of
World War I. The per capita incomes of Australian residents also
rose strongly. Maddison (1995) estimates that they were the
highest in the world by 1870 and that they remained in that
position for the next 30 years.
The fortunes of the mining industry, and of the Australian
economy, subsided during the first half of the new century. The
exceptions were the development of copper and other metals at
Mount Isa, and of iron ore deposits around Iron Knob to supply
BHP’s newly emerging steel mills – first in Newcastle and later
in Port Kembla. But there were no other new major mineral
finds. Furthermore, international trade in minerals was disrupted
by the two World Wars and the Depression of the 1930s.
Although coal, gold iron ore and base metal mining continued in
established areas such as the Hunter Valley, the Illawarra, the
Latrobe Valley, Broken Hill and the Eastern Goldfields of
Western Australia, mining declined in its relative and absolute
importance. By 1960 the minerals and energy sector accounted
for little more than one per cent of Gross Domestic Product and
only around five per cent of exports. This compared with the
situation 100 years earlier in which Butlin (1962) estimated that
mineral production had accounted for more than 15 per cent of
GDP and perhaps 80 per cent of exports.
Two key events then occurred. In 1961, the British government
decided to join the European Economic Community. This had an
almost immediate negative effect on the competitiveness of
Australian agriculture. But offsetting this negative force was the
rise of the Japanese economy, followed by the emergence of the
Asian Tiger economies of Korea and Taiwan, which created an
opportunity for the Australian minerals and energy sector. There
were major discoveries of:
• coal (in New South Wales and Queensland);
• iron ore in Western Australia;
• oil and gas in the Bass Strait, on the North West Shelf of
Western Australia and in the Cooper Basin in South Australia;
• bauxite in Western Australia and Queensland;
• nickel in Western Australia and Queensland;
• copper and other base metals in Queensland and several
other states;
• diamonds in Western Australia; and
• mineral sands in Western Australia.

14 Australian Mineral Economics

 CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

3.5

3.0
3.0

2.6 2.6
2.5 2.4

2.0
2.0 1.9
1.8
1.6
1.5
1.5 1.4
(%)

1.1
1.0
1.0
0.8
0.6 0.6
0.5
0.3

0.0
s

s
s

s
40

50

60

70

80

90

10

20

40

50

60

70

80

90
30

00

30
18

18

18

19

19

19
18

18

18

18

19

19

19

19

19

19

19
-0.5

-1.0

FIG 2.2 - Estimated percentage average real GDP per capita growth in the Australian economy on a decade by decade basis – 1830 to 2000.

Australia emerged as a world-class producer and exporter in economy is that these industries account for
many of these areas. This was particularly the case for iron ore, almost a tenth of national output (and an even
bauxite and alumina, and mineral sands, where it soon ranked as higher proportion of investment spending) while
either first or second in production. While Australia was not the employing just over two per cent of the workforce.
largest coal producer, the high quality of the hard coal in the East
Coast mines made it the leading exporter of this market. Even in During the 1960s, the proportion of mineral resource sector
the field of oil and gas, the significant finds in the Bass Strait and exports started to rise again. In 1974 they passed 30 per cent for
then off the North West Shelf gave Australia a greater level of the first time since the period immediately prior to World War I.
self-sufficiency in petroleum, and made it a significant exporter They have remained at this level for the past 30 years.
of natural gas. Not only has mining emerged domestically, Australian-based
As part of the Bretton Woods gold exchange standard that mining companies began investing internationally in a major
governed the international exchange rate system in the 1950s and fashion in the 1990s. In 1999, Australian-based companies were
1960s, gold had a fixed price of US$ 35 per ounce. Under this active in about 80 nations – see for example Maponga and Maxwell
regime Australian gold production languished. In the 1950s and (2000). The mining services sector has also emerged as an area of
international competitiveness, with Australian mining professionals
early 1960s at just over 30 tonnes per annum, it was less than a
now travelling throughout the world to provide their services.
third of what it had been in 1900. But worse was to come. The
rise of inflation in Australia, combined with a strong Australian Wright and Czelusta (2003) have recently argued that:
dollar in the early 1970s, made gold mining even more marginal.
Minerals constitute a high-tech knowledge
By 1976, Australian gold miners produced only 15 tonnes and in
industry in many countries. Investment in such
1980 only 17 tonnes. The twin towns of Kalgoorlie and Boulder,
knowledge should be seen as a legitimate
which had stood as the nation’s ‘gold capital’ for more than 80
component of a forward-looking economic
years, were surviving fortuitously on the newly emerging nickel
development program.
sector but not because of gold.
But the demise of the Bretton Woods system also led to a This situation seems clearly to have applied to Australia for
change in the status of gold, with citizens of many nations now much of the past century and a half.
able to purchase it as a private asset. In the uncertain 1970s,
dominated by unexpected events such as the OPEC oil price rises COMPLICATING FACTORS WITH MINERAL
and the Iran hostage crisis, the demand for gold rose, and so did
its price. By 1976 it had reached US$ 160 per ounce. By 1979 it PRODUCTION AND CONSUMPTION
was US$ 300 per ounce. In 1980, it peaked at US$ 800 per A variety of factors make the study of mineral production,
ounce. Furthermore, by this time, the value of the Australian mineral consumption and mineral economics generally more
dollar had also fallen back from its high levels in the mid-1970s. complex but also more interesting. As has been noted already in
Even though many of the near surface high-grade deposits had this chapter, one of these is the non-renewable nature of minerals
been exploited, the emergence of metallurgical processes such as and energy resources. Others include:
carbon in pulp leaching, in combination with greater exploration • the fixed locations of deposits (often in remote areas);
and the development of open cut mining in a major way, brought
a dramatic re-emergence of the Australian gold sector. With its • the economic rent that they generate;
price holding at around A$ 500 per ounce for much of the past • the impact of technological change on both the supply and
two decades, Australia emerged again as a major gold producer. demand side;
In 1990, its miners produced 244 tonnes, more than double the
amount of 90 years earlier. At its peak in 1997, Australian mines • the competitive behaviour of mineral producers and purchasers;
produced more than 300 tonnes. • effects of mineral development on indigenous populations;
Through its Industry Commission, the Australian government and finally
published a major study of the minerals and energy sector in • the environmental impact of mining and its mitigation.
1991. It noted that:
The relevance of each of these issues is discussed in the coming
An indication of the importance of mining and chapters – often on more than one occasion. The following table
early-stage minerals processing to the Australian provides a brief guide, should it be required.

Australian Mineral Economics 15

CHAPTER 2: MINERALS, GROWTH AND DEVELOPMENT

Issues Chapters Sinclair, W, 1976. The Process of Economic Development in Australia

(Longman Cheshire: Melbourne).
Locations of deposits and their 4 (trade), 6 (supply),
Tilton, J E (ed), 1992. Mineral Wealth and Economic Development
implications 8 (workforces)
(Resources for the Future: Washington).
Mineral rent 3 (developing nations), 13 (mineral Todaro, M, 1989. Economic Development in the Third World, fourth
policy), 15 (taxes and royalties) edition (Longman: New York).
Impact of technology 5 (demand), 6 (supply) United Nations Development Programme, 2003. Human development
Nature of competition 7 (markets) report 2003 [online]. Available from: <http://hdr.undp.org/reports/
global/2003>. Date accessed: 8 May 2006.
Indigenous populations 17 Wilson, A J, 1994. The Living Rock (Woodhead: Cambridge).
Sustainable development 16 World Bank, 2005. Quick reference tables [online]. Available from:
Smaller regions 18 <http://www.worldbank.org/data/quickreference/quickref.html>.
Date accessed: 8 May 2006.
Wright, G and Czelusta, J, 2003. Mineral resources and economic
REFERENCES development, in Proceedings Conference on Sector Reform in Latin
America (Stanford Center for International Development: Stanford).
Blainey G, 1966. The Tyranny of Distance (Sun Books: Melbourne).
Blainey, G, 2003. The Rush That Never Ended, fifth edition (Melbourne
University Press: Melbourne). APPENDIX – A CLASSIFICATION OF
Butlin, N G, 1962. Australian Domestic Product, Investment and Foreign DEVELOPED AND DEVELOPING NATIONS
Borrowing, 1861 - 1938/39, (Cambridge University Press: Cambridge).
Davis, G A, 1995. Learning to love the Dutch disease: Evidence from the Determining which nations are developed or developing is, in many
mineral economies, World Development, 23(10):1765-1799. respects, an arbitrary decision. Our approach has been to identify
Industry Commission, 1991. Mining and mineral processing in Australia, those nations with Human Development Index values of 0.850 or
Report No 7, February (Australian Government: Canberra) [online]. above as developed. There were 33 nations in this group in 2001.
Available from: <http://www.pc.gov.au/ic/inquiry/07mining/ Ranked in descending HDI order (with Norway as the most
finalreport/index.html>. Date accessed: 8 May 2006.
developed nation and Australia fourth), these nations were mostly
Maddison, A, 1995. Monitoring the World Economy, 1820-1992, located in Western Europe, North America and Oceania, though five
(Organisation for Economic Co-operation and Development: Paris).
Asian nations (including Hong Kong) were also in the group.
Maponga, O and Maxwell, P, 2000. The internationalisation of the
Australian mineral industry in the 1990s, Resources Policy, The remaining 142 nations in Table 3.1 with HDI values less
26(4):199-210. that 0.850 are developing nations. They include all of Africa and
McDivitt, J and Jeffrey, W, 1976. Economics of the Mineral Industries, South America, and most of Asia. The 22 nations closest to
third edition (ed: W Vogely) (American Institute of Mining, developed in this group include the most affluent countries of
Metallurgical, and Petroleum Engineers, Inc: New York). Latin America and the Caribbean, Eastern European nations, and
McLean, I, 2004. Australian economic growth in historical perspective, some of the oil rich nations of the Middle East. The least
The Economic Record, September, 80(250):330-345. developed are mainly in Africa and their HDI values show they
Shaw, A G L, 1966. The Economic Development of Australia, fifth edition, have a long way to go before reaching the ‘developed’ status.
(Longman: Melbourne).

TABLE A2.1
A classification of developed and developing nations using the United Nations Development Program HDI Index for 2001.
(Source: United Nations Development Program, 2003.)
Value of HDI No of countries Countries
Developed nations
≥0.900 22 Norway, Iceland, Sweden, Australia, Netherlands, Belgium, United States, Canada, Japan, Switzerland,
Denmark, Ireland, United Kingdom, Finland, Luxembourg, Austria, France, Germany, Spain, New Zealand,
Italy, Israel
0.850-0.899 11 Portugal, Greece, Cyprus, Hong Kong, Barbados, Singapore, Slovenia, South Korea, Brunei, Czech Republic, Malta
Developing nations
0.800-0.849 22 Argentina, Poland, Seychelles, Bahrain, Hungary, Slovakia, Uruguay, Estonia, Costa Rica, Chile, Qatar,
Lithuania, Kuwait, United Arab Emirates, Bahamas, Latvia, Saint Kitts and Nevis, Cuba, Belarus, Trinidad
and Tobago, Mexico
0.750-0.799 31 Antigua and Barbuda, Bulgaria, Malaysia, Panama, Macedonia, Libya, Mauritius, Russian Federation,
Colombia, Brazil, Bosnia and Herzegovina, Belize, Dominica, Venezuela, Samoa, Saint Lucia, Romania,
Saudi Arabia, Thailand, Kazakhstan, Surinam, Jamaica, Oman, St Vincent and the Grenadines, Fiji, Peru,
Lebanon, Paraguay, Philippines, Maldives
0.700-0.749 22 Turkmenistan, Georgia, Azerbaijan, Jordan, Tunisia, Guyana, Grenada, Dominican Republic, Albania,
Turkey, Ecuador, Palestine, Sri Lanka, Armenia, Uzbekistan, Kyrgyzstan, Cape Verde, China, El Salvador,
Iran, Algeria, Moldova
0.600-0.699 18 Vietnam, Syria, South Africa, Indonesia, Tajikistan, Bolivia, Honduras, Equatorial Guinea, Mongolia, Gabon,
Guatemala, Egypt, Nicaragua, São Tomé and Principe, Solomon Islands, Namibia, Botswana, Morocco
0.500-0.599 15 India, Vanuatu, Ghana, Cambodia, Myanmar, Papua New Guinea, Swaziland, Comoros, Laos, Bhutan,
Lesotho, Bangladesh, Congo, Togo
0.400-0.499 19 Cameroon, Nepal, Pakistan, Zimbabwe, Kenya, Uganda, Yemen, Madagascar, Haiti, Gambia, Nigeria,
Djibouti, Mauritania, Eritrea, Senegal, Guinea, Rwanda, Benin, Tanzania
<0.400 15 Côte d’Ivoire, Malawi, Zambia, Angola, Chad, Guinea-Bissau, Democratic Republic of Congo, Central
African Republic, Ethiopia, Mozambique, Burundi, Mali, Burkina Faso, Niger, Sierra Leone
Total nations 175

16 Australian Mineral Economics


Minerals and the Developing Nations
Philip Maxwell
Mineral Dependent Developing Nations
The Impact of New Mineral Development
The ‘Resource Curse’ Hypothesis
Institutional and Policy Issues
MINERAL DEPENDENT DEVELOPING NATIONS
With the demise of colonialism, the political geography of the
world has been changing. Australia recently celebrated its
centenary of self-government. When Australia became
independent in 1901, there were perhaps 50 autonomous nations.
While many of today’s countries in Europe and the Americas
were already sovereign states, Africa was still largely a colonial
bastion, and much of Asia was in a similar position.
A dramatic change began on the African continent from 1960
onwards. There are now more than 50 independent countries in
Africa. There have been parallel developments in Asia associated
with the independence of India and Pakistan in 1947, of the
South East Asian nations and more recently as a result of the
break up of the Soviet Union.
Teams from more than 200 nations marched at the opening
ceremonies of the Olympic Games in both Sydney in 2000 and
Athens in 2004. While perhaps 30 members of this group are
microstates (places such as Monaco and the Netherlands
Antilles), Chapter 2 highlighted that the United Nations
Development Programme now publishes estimated Human
Development Index values for more than 170 nations in its
Human Development Report. Many of these have either
significant mineral endowments or mineral dependence or both.
While geologists estimate mineral endowments with statements
of reserves and resources, there are several ways of assessing
mineral dependence. Three recent assessments (those of Davis,
19951 and Eggert, 2001, 2003) appear in Table 3.1. The final
contribution focuses only on non-oil and gas mineral producers.
Our view is that where minerals and energy account for 25 per
cent or more of a country’s merchandise exports, its economy
depends significantly on the non-renewable resources sector.
For the second half of the 19th century, the first decade of the
20th century and for much of the past 40 years, Australia has met
most of the criteria for a mineral dependent economy. In the
2002-03 financial year, for example, the mining sector, as
defined in the Australian and New Zealand Standard Industry
Classification code, accounted for over four per cent of Gross
1. This taxonomy was also used by Nankani (1979), Gelb et al (1988)
and Auty (1993).
Australian Mineral Economics
CHAPTER 3
TABLE 3.1
Some recent classifications of mineral dependent nations.
Author Criteria Number of
(and year or period) countries
Davis Minerals GDP/GDP ≥8% and Mineral exports/ 22
(1995) Total merchandise exports ≥40% (1990)
Eggert Mineral exports/Total merchandise exports 34
(2001) >25% (1999)
Eggert Non-fuel mineral exports/Total merchandise 37
(2003) exports >10% (1990-99)
Domestic Product and almost 40 per cent of merchandise
exports. If one defined mining somewhat more broadly to include
basic metal processing and mining services, the share of GDP
rose to more than eight per cent.
Using export data from the 1990s, there are 44 countries listed
in Table 3.2 that meet this mineral dependence criterion. They
consist of 21 hard rock mining nations and 23 economies that
depend strongly on oil and gas production. Additionally, the
table includes 17 other marginal or potential mineral dependent
nations. The criterion for marginal mineral dependence is a level
of exports between ten and 25 per cent of total merchandise
exports. There are additionally a group of five or six African
nations that have either significant mineral potential that has yet
to be developed or, if developed previously, have subsequently
been adversely influenced by major political upheaval. Hence
there are 59 countries on this list of actual, marginal or potential
mineral dependent nations.
From an Australian and more general perspective, there are
several reasons why these countries are of interest. At one level,
there seems potential for those that experience a major mineral
windfall to have the same economic development experience as
Australia. In a similar fashion to the way the impact of the
Victorian and New South Wales gold rushes dramatically
changed the Australian economy, members of this mineral
dependent country group could also be transformed.
At another level, the development of competitive mineral
economies in other nations may threaten the competitive position
of the Australian resources sector. This is not an issue that has
received much attention in the literature but it may have
implications for the economic fortunes of states and smaller
17
CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS

TABLE 3.2
A revised classification of mineral dependent developing nations. Source: Eggert (2001, 2003); United Nations Development Programme (2003).
Value of HDI Countries
Hard rock Oil and gas Marginal or potential
0.800-0.849 Chile Qatar, Kuwait, UAE, Trinidad and Tobago Cuba, Belarus
0.750-0.799 Suriname, Jamaica, Peru Libya, Colombia, Venezuela, Bulgaria, Macedonia, Russia
Saudi Arabia, Kazakhstan Oman
0.700-0.749 Ukraine, Jordan, Uzbekistan Azerbaijan, Ecuador, Iran, Algeria Guyana, Armenia, Kyrgyzstan
0.600-0.699 South Africa, Tajikistan, Bolivia, Syria, Indonesia, Gabon, Egypt Morocco
Mongolia, Namibia, Botswana
0.500-0.599 Ghana, Papua New Guinea Togo
0.400-0.499 Mauritania, Guinea Cameroon, Yemen, Nigeria Zimbabwe, Tanzania, Senegal
<0.400 Zambia, D R Congo, Mali, Niger Angola Mozambique, Burkina Faso, Sierra Leone
Total nations 21 23 15

regions that depend on marginal mineral deposits for their
economic wellbeing. It may also adversely affect Australian
national welfare.
In a more practical and positive vein, the development of
world-class mines and oil wells in other nations provides
opportunities for Australian companies to undertake investment
abroad. As prospects at home become more limited, there is a
natural tendency to focus attention on potentially profitable
ventures elsewhere. During the 1990s there was a strong
movement of investment offshore by Australian mining
companies. Other developed nations with internationally
competitive mining sectors, such as Canada and South Africa,
also participated actively in this area2.
The estimates in Table 3.3 provide one view of the status of the
current world mineral economy. Minerals and energy were
responsible for an estimated US$ 656 billion worth of national
product in 2001. This represented 2.1 per cent of estimated world
Gross Domestic Product. A key point of this table is that the
developed nations, with only 15.3 per cent of the world’s
population, were responsible for more than half of the value of
world mineral and energy production in 2001. This was 1.5 per
cent of their Gross Domestic Product. This seems to imply that the
countries of the developed world are depleting their mineral
reserves at a more rapid rate than those of the developing world.
In the 23 ‘major mineral producing’ nations, minerals and
energy product was 5.7 per cent of GDP. Although this group of
nations was responsible for only 13.3 per cent of world GDP, they
were responsible for 39 per cent of world mineral production.
2. See for example the paper by Maponga and Maxwell (2000) that
discusses the Australian experience, and relevant chapters in Canadian
Minerals Yearbooks, Natural Resources Canada (various years)
discussing the international activities of Canadian mineral companies.
3. Eggert (2001) used a version of this taxonomy in his paper.
With minerals and energy production more difficult in developed
nations, either because mineral deposits are exhausted or factors
such as greater environmental regulation are affecting their
development, the opportunity for this group to expand its share of
output, and benefit from it, seems significant unless their
comparative advantage shifts as they build capital stock.
Finally, Australian-trained mining professionals have been
moving throughout the world, building their careers. The
internationalisation of Australian tertiary education has meant
that many of these graduates have come originally from
developing nations, and will return home to build their own
country’s minerals and energy sectors.
Against this background it is a worthwhile exercise to reflect
on recent views about the way in which the expansion or
contraction of minerals activity will influence developing
mineral economies.
THE IMPACT OF NEW MINERAL DEVELOPMENT
Chapter 2 pointed out that the so-called ‘traditional view’ suggests
that when any nation decides to develop a major mineral
endowment there is a good possibility that this will bring major
economic and social development. Hence, the exploitation of
mineral and energy resources would seem to be a good thing. Yet,
despite increases in measures such as the Human Development
Index in many mineral-rich developing nations, some influential
observers have argued that the economic performance of the
world’s developing mineral economies over the past 40 years has
not been particularly impressive. This observation has led to much
further discussion of what has been happening.
In their recent review of this discussion the authors of
Breaking New Ground, MMSD Project (IIED, 2002) identify the
interplay of three broad groups of factors influencing the
process3. These are:

TABLE 3.3
The contribution of the mineral sector to gross domestic product in selected groups of nations 2001. Source: United Nations (2002).
Country group Population GDP Mineral sector GDP
(million) Per cent of (US$ Per cent of (US$ Per cent of Per cent of
total billion) total billion) total GDP in this
group
Developed nations (33) 935 15.3 24 959 79.5 375 57.2 1.5
Major developing mineral producing nations (23)† 3490 56.9 4184 13.3 256 39.0 5.7
Other developing economies (146) 1705 27.8 2257 7.2 25 3.8 2.0
World (202) 6130 100.0 31 400 100.0 656 100.0 2.1

† Countries in this group included Argentina, Azerbaijan, Brazil, Chile, Colombia, China, India, Indonesia, Iran, Mexico, Namibia, Nigeria, Papua New
Guinea, Peru, Poland, Romania, Russian Federation, Saudi Arabia, South Africa, Syria, Thailand, Trinidad and Tobago, Venezuela.

18 Australian Mineral Economics

 CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS

• external market forces such as declining terms of trade, as total exports, minerals have been Australia’s major export
well as mineral price volatility; category for the past four decades. The situation that has been
faced, with declining terms of trade, is similar to that of many of
• internal economic stresses, which in particular lead to the mineral dependent developing nations. Yet what matters is
reduced economic growth because of Dutch disease effects, profit (rent), not price. If the price of a commodity is falling
(as well as to changing fortunes of the different subnational more slowly than costs, the declining terms of trade could be
regions touched directly or bypassed by new mineral coincident with improving welfare. Another view of movements
developments); and in Australia’s terms of trade since the 1960s appears in Table 3.4.
• distorted processes of policy making, which foster
corruption and excessive rent seeking.
Each of these are now considered in turn. TABLE 3.4
Movements in Australia’s terms of trade since 1960.
Source: Australian Bureau of Statistics, 2006.
External market forces
A nation’s terms of trade is the ratio of the prices of the goods Period Average level Standard deviation
and services that it exports to the price of the goods and services 1960s 116.5 3.6
that it imports. A fall in a country’s terms of trade means that it 1970s 113.8 4.5
needs to produce more of these goods to purchase the same
1980s 101.4 2.3
amount of imports as previously. A rise in a country’s terms of
trade means that it needs to produce fewer exports than before to 1990s 98.5 1.6
purchase the same amount of imports. 2000-01 100.0 na
It is typical for statistical agencies to publish these measures 2001-02 102.6 na
on a regular (say quarterly) basis. The Australian Bureau of
Statistics has conducted this exercise officially for much of the
past 50 years, though it has undertaken a study of trends in the The terms of trade of mineral and energy economies vary
terms of trade since Federation. The information in Figure 3.1 is widely. One indication of this comes from a review of terms of
derived from an Australian Bureau of Statistics study. trade estimates in World Bank (1993). The base year was 1987,
This graph shows a decline in Australia’s terms of trade over when terms of trade stood at 100.
the past century. During this time there have been two or three
notable spikes in the series (in 1924/25, 1950/51 and 1973/74) Group 1985 1991
and also some notable troughs (in 1931/32, 1943/44 and World 106 100
1986/87). But over the period, there has been an apparent fall in
our terms of trade from around 130 in the early years of the 20th High income nations (23) 97 101
century to about 100 at the beginning of the new millennium. Fuel exporters (12) 167 85
Note that the 1999-2000 financial year serves as the base year for Other mineral exporters (21) 122 94
the diagram. Throughout the century, natural resource-based
products (minerals, energy and agriculture) have accounted for
between 75 and 80 per cent of our exports. Manufactures have The volatility of mineral prices – their movement around a
accounted for a similar percentage of our imports. long-term price level or trend – is also an issue. This seems
While the terms of trade measure does not take account of particularly the case for gold, as well as for the mineral
changes in product quality (manufactured goods have been commodities traded in transparent markets such as the London
improving in quality over that period), it does provide a measure Metal Exchange (LME) and the New York Mercantile Exchange
of the perceived difficulties facing countries that depend on (NYMEX or COMEX). It is relevant both for government policy
natural resource-based exports. Averaging around 30 per cent of makers, as well as for mining and oil company executives.

Ratio (1999-2000 = 100) Ratio (1999-2000 = 100)

225 225

200 (b) 1950-51 200

(a) 1924-25
175 (e) 1973-74 175

150 150

125 125

100 100

75 75
(f) 1986-87
50 (d) 1943-44 50
(c) 1931-32
25 Butlin (1977) ABS National Accounts 25

0 0
1900-01 1920-21 1940-41 1960-61 1980-81 2000-01

FIG 3.1 - Movements in Australia’s terms of trade during the 20th century. Source: Australian Bureau of Statistics, 2006.

Australian Mineral Economics 19

CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS
Governments prefer stable and predictable flows of taxes and
royalties to assist national economic management. During
periods of high mineral prices, politicians’ expectations about the
future are typically optimistic. Indeed they may well be
over-optimistic. Governments in mineral-rich developing nations
may be tempted to borrow large amounts to finance development
in other sectors of the economy, expecting that revenue flows
will easily meet debt repayments. Where mineral prices fall, this
often has brought major external debt problems.
Shareholders count on mining company executives producing
healthy profits, while the broader community expects them to be
good corporate citizens, whether at local, regional or national
level. Part of this latter expectation relates to environmental
management, part to contributing to local communities and
regions, and part to paying taxes and royalties. Mining company
workforces anticipate competitive working conditions in the
often remote and difficult conditions in which mines and oil
wells are located. Senior managers and company boards face
major challenges to satisfy each group of their stakeholders.
In their study of metal price volatility for the six metals traded
on the London Metal Exchange between 1972 and 1995
(aluminium, copper, nickel, lead, tin and zinc) Brunetti and
Gilbert (1995) found that volatility had remained relatively stable
over the period. There had been high volatility associated with
two periods of tight demand. Nickel prices had tended to be the
most volatile and copper the least volatile among the group.
These findings were at odds with those of Slade (1991) who, in
analysing data between 1970 and 1986, found greater volatility
in the 1980s than the 1970s. The price volatility of key minerals
in the past decade seems likely to have increased.
Internal economic stresses
Much of the discussion in this area has focused on whether or not
a nation experiences ‘Dutch disease’. Named after the experience
of the Dutch economy in the late 1970s, this is concerned with
the effects on an economy arising from the uncomfortable
co-existence of booming and lagging sectors, which often brings
significant structural adjustment, following the discovery and
initial exploitation of major new mineral resources.
A minerals or energy boom will increase a nation’s exports, and
it may also raise its exchange rate and drive up wages and
inflation, at least in the short term. While the booming sector (say
mining) will cope with this situation, ‘lagging’ domestically-based
tradeable-good industries (such as agriculture and manufacturing)
may struggle to compete with imports. As a result, they may have
to close or severely contract their operations. When the boom
subsides, and exchange rates return to lower levels, there may be
difficulty to re-establish these industries4, 5.
One justification for this view comes from the argument that
‘learning by doing’ occurs in producing manufactured goods, but
not minerals. This improves production efficiency to maintain
and enhance industry competitiveness. When a minerals boom
leads to the complete or partial closure of a nation’s domestic
manufacturing sector, the benefits from the learning effect of
manufacturing will disappear. If the total benefits from
maintaining a manufacturing sector exceed those of mineral
exploitation, the overall impact of mining on an economy would
be negative. Yet much modern mining practice also involves
‘learning by doing,’ whether in the improvement of exploration
practice, mining methods or mineral processing. In leading
mineral-producing nations such as Australia, Canada and Chile,
mining is akin to early stage manufacturing. The associated
4. Corden (1984) has provided one of the standard theoretical
explanations of what happens in economies during resource booms.
5. There are, however, no published empirical studies as yet to support
this argument.
20
mining services sector also entails ‘learning by doing’ for its
practitioners to establish and sustain a competitive edge.
Though identified for the Dutch economy and popularised by
authors such as van Wijnbergen, the ‘Dutch disease’ has a much
longer history and has applied in many other economies. There is
now an extensive literature identifying the effect of the phenomenon
in Australia, Nigeria, Indonesia and several other nations.
The Australian economy experienced some of the symptoms
of Dutch disease in the resources boom period of the early 1970s,
when mineral exports increased dramatically. Exchange rates
rose strongly. In mid-1973 for example, the exchange rate
between the Australian and US dollars was A$ 1 = US$ 1.51.
Unsurprisingly at the time, manufacturing imports were very
cheap. Local manufacturers of things like motor vehicles and
white goods struggled. Australian farmers also faced difficult
times, typically accepting much lower prices than normal in A$
for their internationally traded goods. In addition to this, there
was a wage explosion and accompanying high rates of inflation
soon followed.
The short-term stress that Dutch disease places on a capitalist
economy will be greater if it is close to full employment when
the major impact of new minerals-based development applies,
and it is not easy to supplement the labour force quickly through
migration. If there is large migration as a result of major new
mineral development, this can assist the fortunes of lagging
industries. Where there is major stress on lagging industries, this
may however, be an optimal and welfare maximising response to
changes in a country’s resource endowments.
Distorted processes of policy making
In addition to the potentially negative impacts of external
economic stress and internal economic pressures associated
with Dutch disease, mineral-rich developing nations may be
subject to distorted policy making outcomes that arise from a
number of interrelated causes including:
• excessive rent seeking,
• corruption, and
• an underdeveloped institutional framework.
Where political differences are large, the combination of these
factors can even lead to civil wars where citizens of some regions
stand to derive great potential benefit from a mineral windfall,
yet national governments seek to redistribute the surpluses in a
way that is not favoured by the regional populations.
Although it was noted that mines generate economic rent in
Chapter 1, the concept has not yet been discussed. Economic rent
is the payment that any good (commodity) or service receives in
excess of its supply price when a market is in equilibrium.
In their well-known treatise, Garnaut and Clunies Ross (1983)
provide the following definition of mineral rent:
Mineral rent may be defined as the returns in
excess of those needed to attract factors of
production into the mining industry in the long
run. It is the revenue remaining after all costs
have been deducted. These costs include
exploration outlays, expenditures on mine
establishment and cash operating costs. Unlike
the accountant’s notion of costs, economic costs
include the returns on capital invested, which are
just sufficient to attract the capital to the
enterprise.
It is typical to illustrate economic rent using a diagram such as
Figure 3.2, where the supply curve for producing mines is shown
by SS’, and the equilibrium price that clears the market is P. The
economic rent generated in this case will be given by the area of
the triangle SPQ’.
Australian Mineral Economics
 CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS

governments, national governments, environmental lobby groups

S' and perhaps some other non-government organisations (NGOs).
Each group will have the ability to seek rent payments in varying
P P'
Q' degrees. Some of their demands may be so large that they
Range of undermine the profitability of the project. Senior executives will
mineral rents have to be confident that the project will be profitable if it is to
earned from proceed. There are many cases where companies do not proceed
producing mines with mineral resource development projects in developing
nations because they judge that claims on economic rent will be
excessive.
The potential of considerable new riches may also distort
Range of policy-making processes and encourage corruption. The
costs of organisation Transparency International provides annual
producing estimates in the perceived level of corruption in a broad
mines
S cross-section of countries. In their 2002 report they focused on
public sector corruption, defined as ‘the abuse of public office for
private gain,’ providing estimates of a Corruption Perception
Index for 102 nations. Their group included 26 of the 61
countries in the mineral economy taxonomy in Table 3.2. The
0 Q range of the TI measure is from zero (for the case of extreme
Volume of output corruption) to ten (a total lack of corruption.)
FIG 3.2 - The rent of mines in a competitive market. If mineral economies are more corrupt than non-mineral
economies, one might expect the relationship between perceived
Let us think for a moment what this means in the context of corruption and a measure such as the Human Development Index
the operation of the Western Australian gold industry. Suppose to reflect this. Assuming the Transparency International sample
that the current price of gold is US$ 400 per ounce. Suppose also of countries is representative of the entire population, and its
that there are 50 gold mines operating in the state. It is possible measure of perceived corruption is accurate, the analysis in Table
to generate a supply curve similar to SS’ for these producers. The 3.5 provides a rudimentary assessment. While this analysis is not
amount produced in the state has been around 200 tonnes per concerned directly with whether the windfall causes corruption,
annum (say six million ounces) for much of the past two it shows that the Unweighted Average Corruption Perception
decades. This corresponds to the distance 0Q. Index is in different HDI ranges for developed and developing
The lowest cost producer in the state has an average cost of say mineral- and non-mineral economies.
US$ 150 per ounce, while the most marginal mine produces at Perceived corruption is considerably less in developed than in
US$ 400 per ounce. The first producer will generate an economic developing nations. Yet it does not differ greatly between
rent of US$ 250 per ounce, while the second reaps no rent. developing mineral economies and non-mineral economies. High
While it is possible, in principle, for government to tax away levels of perceived corruption in several of the former Soviet
all of this rent and redistribute it to other parts of the economy, mineral economies meant that the unweighted average perceived
Chapter 15 shows that in practice, it is only possible to access corruption levels were higher in mineral economies in the HDI
part of this amount.
Equally, or even more important for the present discussion, are TABLE 3.5
the key points about mineral rent made by Garnaut (1995): Perceived corruption and stage of development – comparing HDI
• it can be absorbed by any party that has veto power over values for 2001 against the Transparency International Perceived
mine development; Corruption Index for 2002. Source: United Nations Development
Programme (2003); Transparency International (2002).
• it can be dissipated by uncertainty as conflict between
holders of the veto power raises the supply prices of inputs Value of HDI Mineral economies Non-mineral economies
into production; or
No Unweighted No Unweighted
• both of these things can happen. Average Average
Corruption Corruption
Any group that can delay or prevent the approval, construction, Perception Index Perception Index
or operation of mines or oil wells can exert this pressure.
Members of local communities close to a mine, for example, Developed nations
may wish to obtain more of the rent to ensure what they perceive ≥0.900 2 8.8 22 7.94
to be their long-term sustainability. Members of nearby 0.850-0.899 - - 7 6.03
indigenous populations may take a similar view. Where new
Developing nations
mineral development interferes with their cultural heritage, they
may try to prevent it from taking place. Conservation and 0.800-0.849 3 5.73 10 4.17
environmental groups may seek either greater environmental 0.750-0.799 6 2.98 9 3.34
regulation, which is more costly to the mining companies, or 0.700-0.749 4 2.90 10 3.31
propose that mines not proceed at all because they will cause
irreparable long-term damage to the surrounding physical 0.600-0.699 6 4.12 6 3.05
environment. 0.500-0.599 1 3.90 2 1.95
Whether rent-seeking behaviour is excessive or not depends 0.400-0.499 4 2.46 5 2.10
largely on how each stakeholder perceives the outcome of <0.400 2 2.15 3 3.03
negotiations about the sharing of rent. If a company is
considering starting a new mine in a developing nation such as Total developing 26 3.40 45 3.26
nations
Papua New Guinea, Fiji or Tanzania, there will be negotiations
with local indigenous and other communities, regional Total nations 28 74

Australian Mineral Economics 21

CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS
range between 0.700 and 0.799. Perceived corruption in the
desperately poor mineral economies with HDI values less than
0.400 was also greater than in their non-mineral counterparts. In
other HDI ranges, however, perceived corruption was greater in
non-mineral economies than in mineral economies.
The message for any company considering resource sector
investment in a developing mineral economy is clear. Expect
greater levels of corruption than if investing in a developed
nation. But the situation in developing mineral economies does
not seem to differ greatly from that in non-mineral developing
countries6.
A stable government and well-formed institutions in any
nation are more likely to facilitate the orderly development of a
competitive minerals and energy sector. When such institutions
do not exist, or they have been undermined because of political
change, excessive rent seeking and corruption may emerge.
When the African nations became independent, most had few
properly formed institutions and there were few university
graduates with the background and experience to lead them
effectively. In a somewhat different fashion, the demise of the
Soviet Union has been associated with institutional breakdown,
the rise of criminality and corruption in many of its former
republics.
Where newly independent mineral-rich nations consist of
disparate ethnic and cultural populations, institutional structures
are poorly formed and human capital levels are low, there appears
to be a tendency towards civil wars. Ross (2001) identifies 14 civil
wars in resource-rich nations that have taken place over the past 35
years. Nine were in Africa (in nations such as Angola, Nigeria, the
Democratic Republic of the Congo (formerly Zaire), Liberia and
Sierra Leone), two in Indonesia (Aceh and West Papua), two in the
Middle East (Iraq and Yemen) and one in Oceania (the
Bougainville conflict in Papua New Guinea).
The practice of colonising nations of drawing geographical
boundaries, which did not coincide with ethnic and cultural
homogeneity, in combination with weak institutions has also
often been associated with military coups and poor government.
THE RESOURCE CURSE HYPOTHESIS
It became apparent in the late 1970s that the economic
performance of several developing nations with large mineral
and energy endowments, measured particularly in terms of real
GDP growth, did not coincide with traditional expectations.
Nankani (1979) observed this generally for all mineral exporting
economies, while Gelb (1985) considered the situation in oil-rich
economies. Although Gelb found mixed outcomes in his country
case studies, Gelb et al (1988) subsequently posited the existence
of a ‘resource curse’ thesis for the oil-rich developing nations.
Auty (1993) extended the argument that a resource curse applied
also in most ‘hard rock’ developing mineral economies. In an
econometric study of the economic growth experiences of 97
nations between 1970 and 1989, Sachs and Warner (1995)
provided further empirical insight. They have subsequently
published further papers in the area and several other authors
have written about these issues.
Before proceeding further, it is useful to reflect on the
generally understood meaning of the resource curse hypothesis.
Auty (1993, p 1) argues that the essence of the resource curse
view is that:
6. On a different but somewhat related note, Transparency International
(2002) reports that mining is not a major industry in foreign
jurisdictions where senior public officials solicit bribes or where the
size of bribes paid is particularly high for mining companies.
7. The absence of ‘abundance’ or a similar word from the definition
appears to have been a typographical oversight.
22
the economic performance of nations with a
significant mineral (or other natural resource)
endowment may be worse than those without
such endowments.
Atkinson and Hamilton (2003, p 1793) perceive that it is:
the paradoxical but seemingly robust finding of a
negative and significant relationship between
natural resource [abundance]7 and the growth
rate of per capita gross domestic product (GDP).
Sachs and Warner (2001, p 827) describe ‘the curse of natural
resources’ simply as: the observation that countries rich in
natural resources tend to perform badly.
If growth in real GDP, or real GDP per capita, is a reasonable
proxy for economic performance, then it would seem that minerals
may have been a curse since 1970 for those nations that possess
them. The combination of external market forces, internal
economic stresses and distorted processes of policy making during
the last three decades combined to bring this about.
One could describe such an outcome in terms of the simple
diagram depicted in Figure 3.3. After the initial upward impact
of the new resource development, the negative impacts
associated with falling mineral prices, price volatility, Dutch
disease, corruption and poor policy decisions come into play. By
the time that the economy has adjusted, it is behind where it
would have been without the resources windfall. It then begins to
grow at the same rate as it would have without the mineral
windfall. This is the key assumption – that it is behind where it
would have been.
Economic Without
activity resource
windfall
Negative impacts of
External market forces,
Internal economic stresses,
Distorted policy making
With resource
windfall
Initial
impact
Economy
finally
recovers
Time
FIG 3.3 - A simple view of the resource curse hypothesis.
One way of classifying the empirical studies about whether
minerals have been a curse or a blessing is to use the following
three-part taxonomy:
1. the case study-based analyses of growth in real GDP per
capita of by Gelb (1985) and Gelb et al (1988) and by Auty
(1990, 1991, 1993 and 1994);
2. the regression-based econometric analysis of growth in
real GDP per capita associated particularly with the key
study by Sachs and Warner (1995), several further studies
by the same authors, and a series of related studies by
authors such as Gylfason (2001), Atkinson and Hamilton
(2003) and Lederman and Maloney (2002); and
3. the more broadly-based comparative data analyses of authors
such as Davis (1995).
The studies by Gelb and his colleagues focused on the oil-rich
economies that had emerged in the wake of the OPEC oil price
rises in the 1970s. Though Auty’s initial papers were on oil and
Australian Mineral Economics

gas-rich nations, much of his subsequent work has concentrated
on non-oil ‘hard rock’ mineral economies. Both Gelb and Auty
argued that the average GDP per capita growth of mineral and
energy rich nations from the 1970s onwards had been
disappointing. Their contributions have attracted considerable
attention.
Yet it has been the subsequent contributions of Jeffrey Sachs
and Andrew Warner that have had the greatest impact so far on
the debate about whether minerals are a blessing or a curse in
developing nations. In their 1995 study, they used multiple
regression analysis for a cross-section of 97 developed and
developing nations between 1971 and 1989 and considered
factors that explained differences in real GDP per worker growth
(for the economically active population). While interested
particularly in the impact of natural resource dependence (among
which minerals are a major contributor) they also considered a
number of other variables. Their model takes the form:
Growth in real GDP per capita = γ (Log GDP per capita in initial
(of economically active year) +
population) α (Natural resource exports/GDP) +
β’ (Additional variables)
The first of these variables, the logarithm of GDP per capita in
the initial year, has been used in many studies to allow for the
observed tendency of affluent countries to grow more slowly
than poor countries. Their additional initial variables reflected:
• trade policy openness;
• average annual rates of change in the terms of trade;
• gross domestic investment as a percentage of GDP;
• bureaucratic efficiency (indicating ‘corruption, red tape and
judicial independence’); and
• income inequality.
In their later studies, they have reported results for slightly
different variables and time periods. After allowing for the
impact of all of the above factors, Sachs and Warner find that a
negative relationship remains between resource abundance and
economic growth. This is the ‘resource curse’ effect.
With more widespread availability of key macroeconomic data
from nations around the world since 1970 it is now possible to run
the Sachs and Warner regressions to cover three decades. Such
regressions generally continue to support the Sachs and Warner
initial conclusions for the period between 1970 and 19898.
In the light of the above historical observations about the
positive impact of mineral development of nations such as
Australia, these findings come as a surprise. But Sachs and
Warner (1995, p 1) argue also that:
The oddity of resource-poor economies
outperforming resource-rich economies has been
a constant motif of economic history. In the 17th
century, resource-poor Netherlands eclipsed
Spain, despite the overflow of gold and silver
from the Spanish colonies in the New World. In
the 19th and 20th centuries, resource-poor
countries such as Switzerland and Japan surged
ahead of resource-rich countries such as Russia.
In the past 30 years the world’s star performers
have been the resource-poor Newly
Industrialising Economies (NIEs) of East Asia –
8. The basis of this claim is from regressions undertaken by
al Rawashdeh (2004).
9. The source of Gylfason’s natural capital data was World Bank (1997).
Australian Mineral Economics
CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS
Korea, Taiwan, Hong Kong, Singapore – while
many resource-rich economies such as the
oil-rich countries of Mexico, Nigeria, Venezuela,
have gone bankrupt.
Even though there are problems with the availability of
reliable historical data on Gross Domestic Product and natural
resource intensity between nations, Lederman and Maloney
(2002) have recently taken up the empirical issue of considering
their relationship in earlier periods. They use the GDP data of
Maddison (1994) during five periods:
• 1820 to 1870 (19 countries),
• 1870 to 1913 (23 countries),
• 1913 to 1950 (32 countries),
• 1950 to 1973 (37 countries), and
• 1973 to 1989 (37 countries).
They also assume (probably somewhat unrealistically) that the
ratio of natural resource exports to GDP for the nations involved
between 1820 and 1970 had remained constant at 1970 levels.
Because of data limitations, they did not include additional
variables in the specification of their model.
They found a positive relationship between real GDP growth
and natural resource exports as a percentage of GDP between
1820 and 1870, and between 1913 and 1950. There were
negative relationships between 1870 and 1913; 1950 and 1973;
and 1973 and 1989. But t values were only significant at the five
per cent level in the final two periods. While tentative, these
findings question the validity of the resource curse hypothesis
over longer periods. Despite their preliminary nature, these
findings seem consistent with what has happened in countries
such as Australia.
Two other empirical studies by Gylfason (2001) and Torvik
(2002) have extended the Sachs and Warner analysis. Gylfason
argued that, on average, nations with higher percentage levels of
natural capital9 (subsoil mineral and energy assets, farming and
grazing land, forests and fisheries) experienced slower growth in
real GDP per capita between 1965 and 1998. He posited that
natural capital apparently ‘crowds out’ human capital in these
nations, with fewer resources allocated to education spending. In
his paper, Torvik argued that natural resource abundance crowds
out entrepreneurial activity.
Many commentators have expressed doubt about whether GDP
is the most appropriate measure of total production. For example,
it excludes productive non-market activities, as well as those in the
informal economy. Any measure of production should also allow
for the capital depreciation. For these reasons, national accounting
systems struggle to measure production in developing nations.
Hence, comparing GDP per capita levels between nations is often
misleading, even after allowing for purchasing power parity
differences. A more fundamental critique of GDP accounting has
arisen from ecological economists whose alternative measures
suggest that production is declining.
An alternative approach is to explain and analyse variations in
a broader range of variables that reflect economic and social
development. Since development involves several dimensions
other than income growth, this might involve econometric
modelling that seeks to explain variations in factors other than
income (eg human development indices). At a more rudimentary
level it may simply involve broad data comparisons.
Using this later approach, Davis (1995) focused on the
experiences of 79 developing nations (largely in the period
between 1970 and 1990). Using the criteria outlined in Table 3.1,
he defined 22 as mineral economies throughout the period, while
57 were ‘never mineral’ economies. A summary of his findings
appears in Table 3.6.
23
CHAPTER 3: MINERALS AND THE DEVELOPING NATIONS

TABLE 3.6 considerable attention in academic literature11. Others such as

The development progress of long-term mineral economies and Ghana, Namibia, Peru and Tanzania can be added to this list.
‘never mineral’ economies – results from Davis (1995). Chile’s recent experience is of particular interest because, as
Mean values 22 mineral 57 ‘never mineral’ well as exhibiting strong economic growth, the nation’s record
economies economies with other development indicators has been impressive. Poverty
Life expectancy 31.5 26.2 has fallen appreciably, life expectancy has risen to levels similar
(% increase – 1960-91) to those of developed nations, literacy rates are high and the level
of post-secondary education has been rising significantly. A
Infant mortality rate 48.9 36.5
(% decline – 1970-90) summary of some of these trends appears in Table 3.7.
Calorie supply increase per capita 21.1 9.1
(% increase – 1965-90) TABLE 3.7
Primary school enrolment 20.7 16.0 Relative movements of key quality of life indicators in Chile.
(% increase – 1970-90) Source: Maxwell (2004).
Adult literacy rate 47.9 36.0 Indicator Chile High income World
(% increase – 1970-90) nations
Human Development Index 23.1 20.3 Life expectancy (years)
(% increase – 1970-90) 1977 67 75 64
1990 72 77 66
Davis found greater progress in increased life expectancy,
infant mortality decline, nutritional increase, primary school 2000 75.3 78 67
enrolment and adult literacy rate increases among the developing Infant mortality rate (no per ‘000 live births)
mineral economies than their ‘never mineral’ counterparts. The 1970 78 20 85
percentage increase in the Human Development Index between
1990 17 8 52
1970 and 1990 among developing mineral economies was also
higher than among the ‘never mineral’ developing economies 2000 10 6 45
sample10. While these findings focus on alternative measures, Adult literacy rate (per cent)
they may not be at odds with the resource curse view. In the 1990 93 95.5 60
above empirical tests in might be argued that the resource curse
only refers to trends in economic welfare and not their levels. It 1999 95.5 na 64
may be possible to have slow growth and yet have higher Percentage of age group in tertiary education
development indicators. 1970 13 36 13
So where does this leave the empirical debate? Despite the 1990 15.6 33 11
important contributions of authors such as Sachs and Warner in
developing a body of econometric analysis about the impact of 1999 37.5 na na
minerals and energy development on economic growth, much Percentage income share of top quintile
remains to be considered. Further econometric analysis might 1989 48.9 ≈25 na
profitably be extended to consider variations in a wider range of
1998 39.1 ≈25 na
development indicators. If such analysis supports the findings of
authors such as Sachs and Warner, whose major interest has been in Percentage of population below the poverty line
explaining variations in GDP and GDP per worker growth, then the 1992 21.6 na na
resource curse hypothesis will be on stronger ground. Supporters of 1998 21.2 na na
the traditional view doubt that such analysis is possible.
Human Development Index Leading nation Gap
1975 0.702 0.859 0.157
INSTITUTIONAL AND POLICY ISSUES
1990 0.782 0.901 0.119
Despite the prognosis of the resource curse hypothesis, the
2000 0.831 0.942 0.111
historical experiences of nations such as Australia, which moved
from developing to developed status over a relatively short time
period suggests that the combination of a favourable mineral Also, notwithstanding the continuing strength of the copper
endowment, well organised and operated institutions and industry, other parts of the economy have been developing
appropriate government policy can and has led to favourable strongly and several are now competitive.
development outcomes. It is to these later elements that we now One way to assess the economic experience of such nations is
turn. The discussion in this section also has links to a more in terms of the rudimentary framework of Weber-Fahr (2002),
detailed review of mineral policy in Chapters 13 and 15. which suggests that economic performance (encompassing
If one embraced the resource curse hypothesis, mineral-rich somewhat more than strong economic growth) in mineral-rich
developing nations would be better off not to exploit their nations will depend on both the quality of economic
mineral wealth. Yet, as well as the apparently depressing list of management and the quality and stability of key institutions.
bad news stories associated with the economic fortunes of The quality of economic management in any nation depends
mineral economies, several developing nations have derived on a number of factors. The calibre and experience of the civil
positive benefit from mining in the past two decades. Two of the
service is important. So is the integrity and training of the
most prominent are Chile and Botswana. Each has received
politicians who make up the government. This will come under
significant challenge if Dutch disease accompanies a resources
10. This trend is unlikely to have continued since 1990 because of the boom. A simple conceptual formulation might be that:
adverse impacts of the HIV/AIDS epidemic on life expectancy in
many mineral-rich African nations. Quality of = f (Quality of civil service and politicians, level
economic of corruption, nature of policy, relative size of
11. See for example Auty (2001) on the situation in Botswana, and
management resources windfall)
Maxwell (2004) for a discussion about Chile.

24 Australian Mineral Economics


Factors affecting the quality and stability of a nation’s
institutions include the size of its human capital stock, national
ethos about issues of equity such as poverty, income and wealth
inequality and the extent of ethnic and cultural differences within
the population.
It is possible, therefore to hypothesise a relationship of the
form:
Institutional quality = f (Human capital stock, poverty and inequality,
and stability cultural homogeneity, political harmony)
Joining these two equations together, one might therefore argue
that:
Economic = f (Policy environment, relative size of resources
performance windfall, human capital stock, poverty and inequality,
cultural homogeneity and political harmony)
where the policy environment variable incorporates a
combination of the quality of the civil service, political
decision-makers and policies formulated, as well as a lack of
corruption.
The policy environment, human capital stock and extent of
cultural homogeneity and political harmony are all positively
related to the process of development. The relative size of the
resources windfall and the level of poverty and inequality are
inversely related. How a nation develops its mineral energy
resources will depend on the interaction of these positive and
negative forces. In the case of Chile, it seems clear that the
nation has been able to perform well in each of the factor areas
that affect the development process12.
Some other notable recent contributions to the discussion
about public policy have been from the World Bank mining
group and Richard Auty (the former seem to ascribe more to a
resource blessing view of minerals, while the latter sees them
more as a curse).
12. For a more detailed discussion on this issue see Maxwell (2004).
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Atkinson, G and Hamilton, K, 2003. Savings, growth and the resource
curse hypothesis, World Development, 31(11):1793-1807.
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Auty, R M, 1990. Resource-Based Industrialization: Sowing the Oil in
Eight Developing Countries (Oxford University Press: New York).
Auty, R M, 1991. Managing mineral dependence: Papua New Guinea
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Auty, R M, 1993. Sustaining Development in Mineral Economies: The
Resource Curse Thesis (Routledge: London).
Auty, R M, 1994. Industrial policy reform in six large newly industrialized
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Auty, R M, 2001. The political state and the management of mineral rents
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Brunetti, C and Gilbert, C L, 1995. Metals price volatility, 1972-95,
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Eggert, R G, 2001. Mining and economic sustainability: National
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Garnaut, R, 1995. Dilemmas of governance, in Proceedings Mining and
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Century (eds: D Denoon, C Ballard, G Banks and P Hancock), pp
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(Clarendon Press: Oxford).
Gelb, A H, 1985. Are oil windfalls a blessing or a curse? Policy exercises
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Department, World Bank.
Gelb, A H and Associates, 1988. Oil Windfalls: Blessing or Curse?
(Oxford University Press: New York).
Gylfason, T, 2001, Natural resources, education and economic
development, European Economic Review, 45:847-859.
International Institute for Environment and Development (IIED), 2002.
Breaking New Ground, Mining, Minerals, and Sustainable
Development – The Report of the MMSD Project (Earthscan
Publications: London) [online]. Available from: <http://www.iied.org/
mmsd/finalreport/index.html>. Date accessed: 8 May 2006.
Lederman, D and Maloney, W, 2002. Open questions about the link
between natural resources and economic growth: Sachs and Warner
Revisited, Natural Resources and Growth Conference, Bank of Chile,
January [online]. Available from: <http://www.bcentral.cl/eng/std
pub/studies/workingpaper/htm/141.htm>. Date accessed: 8 May 2006.
Maddison, A, 1994. Explaining the economic performance of nations,
1820-1989, in Convergence of Productivity: Cross-National and
Historical Evidence, (eds: W Baumol, R Nelson and E Wolff) pp
20-61 (Oxford University Press: New York).
Maponga, O and Maxwell, P, 2000. The internationalisation of the
Australian mineral industry in the 1990s, Resources Policy,
26(4):199-210.
Maxwell, P, 2004. Chile’s recent copper-driven prosperity: Does it
provide lessons for other mineral-rich developing nations? Minerals
and Energy, 19(1):16-31.
Nankani, G, 1979. Development problems of mineral exporting countries:
A background study for World Development Report 1979, World
Bank Staff, Working Paper No 354, Washington.
Natural Resources Canada, various years. Canadian Minerals Yearbook,
[online]. Available from: <http://www.nrcan.gc.ca/mms/cmy/index.
htm>. Date accessed: 8 May 2006.
Ross, M, 2001. Extractive sectors and the poor, September, Oxfam
America Report: Boston.
Sachs, J and Warner, A, 1995. Natural resource abundance and economic
growth, development discussion paper no 517a, Harvard Institute for
International Development.
Sachs, J and Warner, A, 1997. Sources of slow growth in African
economies, Journal of African Economies, 6(3):335-376.
Sachs, J and Warner, A, 2001. Natural resources and economic
development: The curse of natural resources, European Economic
Review, 45:827-838.
Slade, M E, 1991. Market structure, marketing method, and price
instability, Quarterly Journal of Economics, 106:1309-1340.
Torvik, R, 2002. Natural resources, rent seeking and welfare, Journal of
Development Economics, 67:455-470.
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unscrupulous investors kill sustainable growth in its tracks,
highlights new index, press release, 28 August, Berlin.
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Weber-Fahr, M, 2002. Treasure or Trouble? Mining in Developing
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org>. Date accessed: 8 May 2006.
25

Trade in Minerals
Philip Maxwell
Why Trade Takes Place
The World Economy, International and Interregional Trade
Recent World Production and Trade in Minerals and Energy
Australian Production and Trade in Minerals
Transport Costs and the Direction of Minerals and Energy Trade
Minerals Trade and Exchange Rates
WHY TRADE TAKES PLACE
When people, companies or nations freely trade goods and
services with one another, they increase their respective levels of
economic welfare. They normally use money1 – serving in its
role as a medium of exchange and a unit of account – to facilitate
these exchanges. A simple diagrammatic analysis, such as that in
Figure 4.1, illustrates how two parties, who choose to trade with
one another at an agreed rate of exchange, can move to a higher
level of welfare. For the purposes of this example, assume that
one of the parties sells minerals, while the other sells all other
final goods and services. Only the first party is considered to
keep the example as simple as possible.
Assuming a production possibility curve DBAE, the economic
actor (person, company or country) will initially be at point A on
the production possibility frontier. Let us call this actor Smith.
Smith has the opportunity to trade with another actor, Jones, at
an exchange rate given by the slope of the line BC. Smith
chooses therefore to move around on the production possibility
curve from A to B, producing more minerals and less other goods
and services. Smith then sells MBMC of minerals to Jones for
GBGC of other goods and services, thereby moving along the
trading possibilities curve BC to the point C. At point C, Smith
receives more minerals and other goods and services than before
trade and is clearly better off. By using the same methodology it
is possible to draw a diagram to show that Jones will also be
better off as a result of trade.
Whether this trade takes place within a nation, in an
intraregional framework (eg within the Sydney metropolitan
area) or interregional context (eg between the Pilbara region of
Western Australia and the Illawarra region of New South Wales),
or it flows across international frontiers (between the Pilbara and
China), does not matter in a welfare changing sense. Yet
movements of goods and services internationally are typically
1. It is also possible to undertake barter trade or counter trade to
achieve a similar result, though the use of money tends to eliminate
the ‘coincidence of wants’ condition.
2. It is also possible for trade barriers to exist between states within
nations.
Australian Mineral Economics
CHAPTER 4
Minerals
After
D B trade
MB
C
MC
A
MA
Before
trade
O GB GA GC E Other goods
and services
FIG 4.1 - The gains from trade – a simple view.
more complex because different countries often have different
currencies, and may erect trade barriers2.
The extent of interregional and international trade has grown
over the past two centuries as the world has moved more and more
towards becoming a global economy. From time to time these
trends have been reversed by war, politics and the business cycle.
There is now a broad field of specialisation within economics
that considers the area of international trade. The pioneer of
modern international trade theory was David Ricardo who, in
The Principles of Political Economy and Taxation in 1817,
developed the idea of comparative advantage. He used this
concept in his classical theory to explain trade between nations
such as England and Portugal. According to Ricardo, a countries
tend to export those goods and services where their margin of
superiority is greater, or their margin of inferiority smaller, than
their trading partners. Even though Portugal was a more efficient
producer of both wine and cloth, he argued that each country
would gain from trade when Portugal exported wine (and
imported cloth) and England exported cloth (and imported wine).
27
CHAPTER 4: TRADE IN MINERALS

One limitation of the original Ricardian model was that it was 8 7.5%
restricted to differences in the productivity of just one factor of Exports
production (labour). Also it did not explain the determinants of 6.1% Production
comparative cost differences. In developing the neoclassical 6
theory of international trade, three economists (Heckscher, Ohlin
and Samuelson) extended Ricardo’s theory. They did this by 4.5%
recognising that countries are endowed with many factors of 4.1%
3.8%

(%)
4
production but in different proportions, and arguing that these 3.5%
explain differences in international costs and form the basis for 2.7%
international specialisation. 2.4%

In his explanation of the Heckscher-Ohlin-Samuelson model, 2

Grubel (1981, p 24) states that:
A country exports goods which intensively use
the factor of production with which it is relatively 0
well endowed, and imports the good using Total Agriculture Mining Manufacturing
intensively the factor with which it is relatively
poorly endowed. FIG 4.2 - Average growth rates of world exports (by volume)
and production – 1950 to 2003. Source:
Remembering the nature of the economist’s production World Trade Organization (2004).
function, what this implies is that a country relatively rich in
capital will export capital-intensive goods and import
labour-intensive goods. In a similar vein a natural resource 10000
intensive country such as Australia will export minerals (and
agricultural goods) and import manufacturing goods. Although Manufacturing

the theory of international trade has now moved considerably Total

beyond the neoclassical model3, there is general agreement that merchandise
this view normally provides a reasonable explanation of why trade

both international and interregional minerals trade takes place. 1000 Mining
Against this background, the focus for the remainder of this Agriculture
chapter is in considering the importance and direction of
minerals and energy trade and in assessing Australia’s role as a
major mineral exporter. The following sections consider these
issues in further detail. Because transport costs play an important 100
role in mineral trade, this issue is discussed in the fifth section of
1950 1960 1970 1980 1990 2000
the chapter, prior to the brief concluding commentary. The final
section focuses on the importance of exchange rates as a
determinant of comparative advantage in minerals trade. FIG 4.3 - The growth of international trade – 1950 to 2003.

THE WORLD ECONOMY, INTERNATIONAL AND
INTERREGIONAL TRADE
Despite the limitations discussed in Chapter 2, it is common
practice to use Gross Domestic Product as the standard measure
of the size of an economy in any given period. Chapter 3 noted
that the United Nations estimated World GDP to be US$ 31 400
billion in 2001. As can be seen in Table 3.3, the 33 developed
economies, with a little more than 15 per cent of the world’s
population, generated almost 80 per cent of this total, while the
remaining 169 developing nations produced just over 20 per cent.
This table showed as well that the minerals sector, defined
narrowly, was responsible for 2.1 per cent of world GDP in that
year.
National and international statistical agencies have been making
GDP estimates consistently since about 1950. Since that time, real
GDP has grown on average at about 3.8 per cent per annum.
Mineral production has increased at 2.7 per cent per annum,
agriculture at 2.4 per cent and manufacturing at 4.5 per cent.
Because minerals are inputs into final goods and services, most
mineral production is traded either within regions, between
regions or between nations. The exception is where firms use
vertical integration to control different parts of the production
process and trade does not formally take place. Since mineral
production has grown more slowly than total production, one
would expect mineral trade also to grow more slowly. This would
3. For a further discussion of international trade theory it is useful to
consult one or more of a large number of international economics
textbooks.
certainly appear to be the case within nations. But it has not been
the case with international trade. The estimates in Figure 4.2 show
that international mineral trade grew at an average of 4.1 per cent
per annum, while real GDP grew at 3.8 per cent.
Also, as can be seen from Figure 4.3, international mineral
trade has grown at a faster rate than trade in agricultural goods
but more slowly than manufacturing trade and total merchandise
trade over this extended period.
Several factors seem to have contributed to the more rapid rise
in international trade than production over the past half century.
Let us consider some of them briefly:
• In the aftermath of World War II and the Depression of the
1930s, international trade in 1950 stood at rather low levels.
In a subsequent period of relative peace in the world
economy, one would expect the rate of international trade to
increase strongly.
• There has also been the continuing rise of the number of
nation states. There were fewer than 100 nations in 1950 and,
as noted in the previous chapter, there are now more than
200. With more countries, it seems obvious that more
international trade will take place.
• With the demise of Communism in the early 1990s, many
developing nations have now embraced export-oriented
policies, rather than import-replacement strategies, as a way
of seeking to promote development. This has provided a
further stimulus to international trade.
• Additionally there has been a recent movement towards
lowering of trade barriers throughout the world. Free trade
leads to more trade.

28 Australian Mineral Economics

 CHAPTER 4: TRADE IN MINERALS

TABLE 4.1 • There has also been a major revolution in bulk shipping
Estimated world new mineral production – 2002. Source: costs, a factor which will be returned to later.
United States Geological Survey, 2006; Natural Resources
Canada, 2006; US Energy Information Administration, 2006.
RECENT WORLD PRODUCTION AND TRADE IN
Energy minerals Amount Price/unit Value MINERALS AND ENERGY
(US$) (US$ M)
Narrowly defined, the value added by mineral and energy
Hard coal (Mt) 4000 38 152 000
production (its contribution to World Gross Domestic Product)
Brown coal (Mt) 886 20 17 720 amounted to US$ 656 billion in 2001. This was approximately 2.1
Crude oil (‘mill bpd) 77.9 26 739 271 per cent of total GDP. Periods of higher minerals and energy prices
Natural gas (tr cu ft) 95 650 61 750 (as in 2004) would increase this percentage, as would a broader
view of the resources sector, which includes all basic mineral
LNG 55 000
processing as part of mining (rather than in manufacturing).
Uranium (t) (2001) 36 800 20 938 771
One can obtain another view of world mineral usage by
Total fuel 1 026 512 estimating the annual value of new production of the energy
Metals minerals, major metallic minerals, and non-metals. Such an
Aluminium (kt) 25 900 1430 37 037 exercise depends on a number of assumptions concerning the
degree of processing of key minerals and without considerable
Antimony (kt) 143 3300 472
discussion and qualification should be seen only as indicative,
Beryllium (t) 132 716 300 95 rather than authoritative. The results of such an exercise appear
Chromite (kt) 4650 200 930 in Table 4.1. The value of fuel mineral production in 2002 was
Cobalt (t) 47 600 15 229 725 more than US$ 1000 billion. The value of newly mined metals
was slightly more than US$ 150 billion and of newly mined
Copper (kt) 13 600 1670 22 712 non-metals a little more than US$ 50 billion. It should be noted
Gold (t) 2550 9 734 300 24 822 that steel production is not included in this calculation and
Heavy mineral sands 920 neither is cement. Their inclusion would significantly increase
Iron ore (Mt) 1050 30 31 500 the estimates of the value of production in the metals and
non-metals areas.
Lead (kt) 2910 452 1315
The World Trade Organization publishes estimates of
Lithium (t) 12 500 7980 100 international trade in its annual publication, International Trade
Magnesium (kt) 508 2535 1288 Statistics. A summary of its estimates in key product groups for
Molybdenum (kt) 121 9.2 1113 2002, and their growth since 1995, appears in Table 4.2. These
Nickel (kt) 1340 6772 9074
data show that minerals trade has been accounting for over a
tenth of world merchandise trade in the recent past. Although
Niobium (kt) 32.8 14.5 476 part of this trade involves the movement of recycled metals and
Platinum group metals 3963 non-metals, by comparing data in Tables 4.1 and 4.2, it is clear
Silicon 4028 from 2002 data that much new mineral production now flows
across international borders.
Silver (t) 20 000 144 606 2892
Tantalum (t) 1480 66 700 99
TABLE 4.2
Tin (kt) 209 4500 941
International merchandise trade 1995 - 2002.
Tungsten (t) 58 800 7300 429 Source: World Trade Organization (2003).
Vanadium (t) 50 500 3520 178
Category Value Per cent Annual percentage
Zinc (kt) 8930 880 7858 (US$ B) share change
Other (estimate) 2100 2002 1995 2002 1995- 2001 2002
Total metals 155 063 2000
Non-metals Agricultural products 583 11.7 9.3 -1 0 5
Asbestos (kt) 1970 308 607 Mining products 788 10.7 12.6 10 -9 -1
Boron (kt) 4550 500 2275 Ores and other minerals 63 1.2 1.0 1 -4 1
Bromine (kt) 548 1600 877 Fuels 615 7.3 9.8 13 -9 0
Diamonds 8000 Non-ferrous metals 110 2.2 1.8 3 -10 -2
Gypsum (Mt) 101 12 1212 Manufactures 4708 74.3 75.1 5 -4 4
of which:
Iodine (t) 20 700 12 700 263
Iron and steel 142 3.1 2.3 -1 -6 7
Nitrogen fertiliser (Mt) 108 155 16 740
Chemicals 660 9.7 10.5 4 3 10
Phosphate rock (Mt) 137 27.5 3768
Unspecified products 194 3.0 3.0 na na na
Potash (Mt) 44.1 110 4851
All products 6272 100 100 5 -4 4
Salt (Mt) 217 25 5425
Sand and gravel (Mt) 110 2500
Other (estimate) 5000 As can be seen in Table 4.3, the ratio of international trade in
non-fuel minerals to their total new production stood at 0.84.
Total non-metals 51 517
Even though many nations make strong efforts to enhance their
Estimated total mineral 1 233 092 self-sufficiency in the supply of the energy minerals, almost 60
production per cent of new production was traded internationally in 2002.

Australian Mineral Economics 29

CHAPTER 4: TRADE IN MINERALS

TABLE 4.3 Australia’s Mineral Reserves

International trade in minerals as a share of new mineral
production 2002. Source: World Trade Organization (2003). Despite its extended exploitation and the finite nature of
Australia’s mineral endowment the Australian Bureau of
International trade New production Ratio Statistics (2000) reported that:
Non-fuels 173 206 0.840
Given its relatively small population, this statement implies
Fuels 615 1027 0.599 that Australia is likely to continue to be a significant
Mineral products 788 1233 0.639 mineral producer and exporter for a large number of
minerals in the foreseeable future (ie for most of the 21st
century).
AUSTRALIAN PRODUCTION AND TRADE IN Australia continues to rank highly as one of the world’s
MINERALS leading mineral resource nations. It has the world’s largest
Economic Demonstrated Resources (Reserves) of:
Chapter 2 highlighted the important role that minerals and
energy have played in the development of the Australian
economy since European settlement. Initiated particularly by the lead mineral sands
gold rushes in the 1850s, by Federation in 1901 the new nation’s nickel (ilmenite, rutile and zircon)
mineral economy had expanded into a number of other areas.
tantalum silver
Although minerals production and trade subsided in importance
in the first half of the 20th century, a major resurgence from 1960 zinc uranium
until the present time has re-established Australia as one of the
world’s leading mineral producing and exporting nations. As the In addition, Australia’s EDR is in the top six worldwide for:
insert on the following page shows, recent best estimates show
that Australia’s mineral reserves4 are presently at high levels for
a wide range of minerals. bauxite black coal
The Australian Bureau of Statistics publishes official data on brown coal copper
Australian mineral production and trade. In the production area cobalt gold
its publications Australian Mining Industry 1998-99 (Australian iron ore lithium
Bureau of Statistics, 2000) and Mining Operations Australia
2001-02 to 2002-03 (Australian Bureau of Statistics, 2004) manganese ore rare earth oxides
present the most recent available official information as this industrial diamond vanadium
chapter is compiled. The ABS publication International Trade in
Goods and Services, Australia (cat no 5368.0) provides current
information on the commodity composition and direction of Coal mining and the oil and gas sector stand out with sales in
Australian international trade in minerals and energy. The both sectors exceeding A$ 16 billion. Though considerably
material in Table 4.4, for the 2002-03 financial year, is derived smaller, iron ore and gold were also both major sectors with sales
from Australian Bureau of Statistics (2004). more than A$ 5 billion. Copper, silver-lead-zinc, bauxite and
nickel were also major sectors. Other important areas, though
much smaller in size, were mineral sands (generating sales of
TABLE 4.4
A$ 869 million) and diamond mining (A$ 771 million)5.
Australian mineral production 2002-03.
Source: Australian Bureau of Statistics (2004). With the exception of oil, Australia is self-sufficient and a
potential exporter in each of the major mineral sectors listed in
Sales and Wages and Industry Table 4.4. Yet, because minerals are typically inputs into the
service income salaries value added
manufacture of final goods, it does not necessarily follow that a
($ M) ($ M) ($ M)
major mineral-producing nation will also export these resources.
Coal mining 16 862 1921 8254 An alternative is to establish downstream processing, which then
Oil and gas extraction 17 225 779 15 263 provides a platform for manufactured exports. These will add
Iron ore mining 5307 500 3779 potentially greater value and profit for domestic producers.
Although policymakers and commentators have actively
Copper ore mining 2223 211 825 promoted the value adding argument in many mineral-
Gold ore mining 5932 670 2718 producing nations, the realities of comparative advantage are that
Mineral sand mining 869 108 369 such manufactures (whether produced for export or as import
replacements) tend not to replace mineral exports in any
Silver-lead-zinc ore 1775 216 679
mining significant fashion unless they are in countries with major
internal markets.
Bauxite, nickel and metal 2750 240 1367
nec Consider, briefly, the case of iron ore. Together with Brazil,
Australia has been one of the two major producers of high
Other mining† 3996 479 1941 quality iron ore to world steel producers since the 1960s. The
Services to mining 6530 1562 2451 overwhelming majority of Australian production has come from
Total mining 63 473 6694 37 644 the remote Pilbara region in Western Australia.
Gross Domestic Product 731 021 In a hypothetical exercise, Stewardson (1992, p 3) considered
Australian iron ore and steel exports for the 1990-91 financial
Mining GDP/GDP 5.1%
year. He estimated that if Australian producers converted all of
† Includes construction material mining and mining not elsewhere their iron ore exports into steel, and then sold this into the world
classified. market, export values would increase from $2.83 billion to
$16.75 billion. This would have represented a third of the
internationally traded steel market. Stewardson argued that
4. There is further discussion about mineral reserves in Chapter 6. achieving this level was not possible because of factors such as
5. These data appear in Department of Industry and Resources (2003). market structure, transport costs, the availability of other factors

30 Australian Mineral Economics

 CHAPTER 4: TRADE IN MINERALS

of production, speed and flexibility of response to demand, the TABLE 4.5

market for by-products and, most importantly, costs of Key mineral and energy exports – Australia 2002-03.
production. All of these factors made the comparative advantage Source: Australian Bureau of Statistics (2004).
in steel production lie with nations such as Japan, Taiwan and
Korea. It has recently moved to China in a most significant way. Commodity Value (A$ M) Per cent
Even when Australian-based companies such as BHP Billiton Coal 11 946 10.4%
have made partial attempts at downstream processing of iron ore, Crude petroleum oils, etc 5881 5.1%
they have struggled to make profits. The difficulties with high Gold (non-monetary) 5584 4.8%
construction costs at the Port Hedland hot briquette iron plant,
and ongoing technical difficulties with its operation, provide a Iron ore and concentrates 5328 4.6%
topical recent example of the challenges in changing comparative Aluminium 4059 3.5%
advantage. While change over time does take place, the nature of Aluminium ores and concentrates 3587 3.1%
the process is often difficult to predict. It may happen gradually,
Natural gas 2620 2.3%
suddenly, or not at all.
Other petroleum oils 2441 2.1%
Against this background, the data in Table 4.5 reflect the recent
importance of key mineral exports, while Figure 4.4 shows the Copper 1327 1.2%
continuing strong performance of Australian mineral and energy Base metal concentrates (other 1216 1.1%
exports since 1970. The Australian Bureau of Statistics presently than Fe, Cu, Ni, Al, U and Th)
publishes monthly estimates of Australia’s exports and imports in Other minerals 14 517 12.6%
its International Trade in Goods and Services.
Total merchandise exports 115 142 100.0%
In 2003-04 eight of the top 12 export commodities6 were
related to the minerals and energy sector. They were iron ore and
concentrates, aluminium ore and concentrates, coal, crude 60%
petroleum oils, refined petroleum oils, natural gas, aluminium
and non-monetary gold. Several other mineral commodities 50%
including copper, nickel, other base metals, mineral sands and
diamonds also make important contributions to merchandise
40%
exports.
The significance of minerals and energy exports since 1970
30%
stands out in Figure 4.4. Following the entry of Britain to the
European Common Market (now the European Union) in 1960,
20%
Australian farmers faced difficult trading conditions. The
manufacturing sector subsequently struggled as the Australian % of merchandise exports
Government reduced tariffs. The strong export performance of 10%
% of total exports
the minerals and energy sector in this changed environment has
been impressive. Minerals have consistently contributed more 0%
than 40 per cent of Australia’s merchandise exports, and more 1970 1975 1980 1985 1990 1995 2000 2005
than 30 per cent of Australia’s international trade in goods and
service since 1975. In the past five years it has been on average FIG 4.4 - The key role of Australian resource sector exports
in excess of A$ 50 billion per annum. This seems destined to 1969-70 to 2003-04.
continue in the foreseeable future.
Once this ore is mined, producers must send it to a port where it
TRANSPORT COSTS AND THE DIRECTION OF will be shipped to the customer in a city such as Kobe, Anshan or
MINERALS AND ENERGY TRADE Pohang. The producer typically bears the cost of delivering the
mineral to the port, while the buyer is responsible from that point
Discussion about the economics of value adding, in the preceding onwards. The cost of transporting iron ore has the potential to be
section, laid some of the groundwork for analysing the direction of more than its sale price. Historically this has meant that
Australia’s mineral and energy trade. Comparative advantage is steelmakers in places such as North America and China have
the key to understanding this. If Australian iron ore producers favoured local mines, even though their ore is inferior to that
despatch most of their output to China, Japan, Korea and Taiwan, coming from high-grade mines in distant nations.
while Brazilian producers send most of their ore to Europe and
North America, this is a reflection of the respective comparative Gold can travel easily all over the world. Even though it is less
advantage that producers in each nation hold. valuable – around US$ 1500 per tonne – it has been recently
profitable to ship Australian nickel concentrate (say ten to 15 per
An important factor that influences comparative advantage and cent nickel metal) from ports such as Esperance in Western
the extent of resources trade is a mineral commodity’s value to Australia to Finland and Canada. A similar situation applies with
weight ratio. Sending Australian gold anywhere in the world is mineral commodities such as alumina, zinc concentrates, copper
comparatively inexpensive. Even though security may be an concentrates, lead, ilmenite and rutile. Lower value commodities
issue, it is a relatively straightforward matter to send a bar of such as coal and iron ore have traditionally been more
gold to London, New York, Mumbai or Hong Kong and sell it constrained in their movements. Large shipments of Australian
there. The cost of transport is relatively small. iron ore to Europe must compete with supplies from closer
By contrast, trading lower value commodities profitably across places (Sweden, Ukraine, Mauritania, Brazil, India, South
international frontiers is a more contentious issue if a business is Africa, etc). This has the capacity to make it less than
trying to make and maximise profits. While the price of gold competitive.
may be US$ 500 per ounce, the price of a tonne of high quality While, at one end of the spectrum precious mineral producers
iron ore mined in the Pilbara will be perhaps US$ 50 per tonne. sell gold, diamonds and the platinum group minerals in global
markets, industrial minerals such as gravel, sand, cement and
6. The ABS used the three-digit level of the Standard International aggregates typically trade only in local and regional markets.
Trade Classification (SITC) in developing this list. Only occasionally do they move across international frontiers.

Australian Mineral Economics 31

CHAPTER 4: TRADE IN MINERALS

($US/t)
The simple inverse relationship between the market value of 65
minerals and the transport cost to value ratio in Figure 4.5 60 Shipping costs
provides an indicative insight into the importance of transport 55
Rail/Port costs
costs. This may be described as a transport cost market value 50
Mining costs
curve. While the transport cost to value ratio for gold and 45

platinum group metals may be 0.01 or 0.02, even from faraway 40

places, the value of this ratio for commodities such as iron ore 35
30
and coal from remote parts of the world is often greater than one.
25
20
Market
15
value
10
Gold, PGMs 5
0
Base metals Queensland NSW NSW surface North & Central Wyoming South Africa Indonesia
surface underground Appalachia surface surface surface
underground
Base metal concentrates A
($US/t)
Oil and gas 60
55 Shipping costs
Iron ore
50
Rail/Port costs
Coal, fertilisers 45
Mining costs
40

35
Construction materials
30

25
Transport cost
20
to value ratio
15
10
FIG 4.5 - Mineral commodity values and transport costs.
5

For example, the cost of transporting a tonne of coal from an
open cut mine in Central Queensland to Europe may be as much
as twice the cost of mining it. For international trade to occur in a
case such as this:
• either the quality of the distant mineral commodity must be
considerably higher than that available from nearer to the
market place;
• transport costs must have fallen; or
• both factors must apply.
In his influential paper on bulk trade and maritime transport
costs, Lundgren (1996) observes that:
Since the 1950s a transport revolution has
occurred comparable to events of the late 19th
century when sailing ships were replaced by
steam vessels. Freight rates for bulk products
have decreased 65 - 70 per cent due to improved
maritime technology. Formerly separate markets
for bulk products have been unified globally.
Reduced maritime transport costs in the immediate post World
War II period led to a leftward shift in the transport cost market
value curve and a corresponding increase in the potential size of
markets for minerals produced in previously remote locations.
Parallel reductions in internal transport costs (rail and road),
and increases in the efficiency of ports in mineral producing
nations, tended to lag behind the dramatic reductions in shipping
costs. Yet in nations such as Australia, the implementation of a
national competition policy in the early 1990s sought to increase
efficiency and thereby establish greater competitiveness in this
area as well.
Crowson (1998) provides one insight into the importance of
transport costs in the exporting of coal to major markets in the
mid-1990s. His data show rail/barge, shipping and average
mining costs in US dollars from key producing regions to both
the Japanese and European markets. These are reproduced in
Figure 4.6a for Japan and Figure 4.6b for Europe. In the case of
Japan, the sum of production and transport costs from the two
main Australian coal mining regions (Queensland and New
South Wales) was slightly higher than for Wyoming, South
Africa and Indonesia at this time. Presumably this was offset
0
Queensland
surface
NSW
underground
NSW surface North &
Central
Wyoming
surface
Colombia
surface
South Africa
Surface
Indonesia
surface
Appalachia
B underground
FIG 4.6 - The importance of production and transport costs for coal
sold in the Japanese and European markets in 1995. (A) Japan,
(B) Europe.
either by higher quality, or more certainty of long-term supply, or
both, from the Australian mining regions. The non-Australian
producers had a more pronounced cost advantage to European
destinations as illustrated in Figure 4.6b.
One feature that stands out for most producers is that domestic
rail and port costs are typically greater than international
shipping costs, involving travel over greater average distances.
While this implicitly points to the great improvements in
efficiency of bulk shipping since 1950, there is a continuing
challenge of making domestic transport links more efficient. This
issue was associated in early 2005 with a broader debate about
the relative levels of exports and imports and the size of the
current account deficit in Australia.
Another way of viewing this data is to compute the percentage
contribution of transport costs to the total costs of coal. As can be
seen in Figure 4.7a and b, these often exceed 50 per cent.
Major improvements in transport technology have a significant
effect on country and company competitiveness in the minerals
sector. The present and future status of the transport system
determines the countries with which producers of lower value
commodities such as iron ore, coal and fertilisers are able to
trade profitably.
The data presented in these figures provide a useful
background to explain why Australia trades many of its higher
valued commodities throughout the world, while its lower value
commodities have more limited markets. Hence, its major
markets for coal and iron ore are in major Asian nations, while it
faces more serious competition in Europe from African and
South American producers. Yet transport costs alone do not
entirely explain the direction of minerals trade. The quality of a
nation’s or region’s mineral endowment is also important,
together with the status of environmental policy, its regulatory
environment and the absolute and relative levels of exchange
rates and movements in them.

32 Australian Mineral Economics

 CHAPTER 4: TRADE IN MINERALS

90% fixed, ie the value of the local currency is set at a certain level in
80% relation to other key currencies, a nation’s Central Bank will use
its reserves to buy and sell currency to ensure that this stable
70%
relationship continues. Foreign exchange markets reflect current
60% levels of exchange rates. The values of these exchange rates are
50%
readily available in newspapers or on the internet.
As well as reflecting its value in terms other specific currencies
40%
(eg A$ 1 = US$ 0.75, A$ 1 = 0.61 Euro, A$ 1 = £St 0.41, or A$ 1
30% = $NZ 1.10), another way to view the value of a country’s
20%
currency is in terms of the value of a Trade-Weighted Index. The
authors of Reserve Bank of Australia (2002) note that:
10%
The TWI is a weighted average of a basket of
0%
Queensland NSW NSW surface North & Central Wyoming South Africa Indonesia currencies that reflects the importance of the sum
A surface underground Appalachia
underground
surface surface surface
of Australia’s exports and imports of goods by
100% country. The TWI is often used as one indicator
90% of Australia’s international competitiveness and
80%
is a useful gauge of the value of the Australian
dollar when bilateral exchange rates exhibit
70%
diverging trends.
60%

50%
The Reserve Bank has computed this measure on a daily basis
for the Australian dollar since 1970, when its value was set at
40%
100. The graph in Figure 4.8 shows movements in the index
30%
measured in December of each year between 1970 and 2004. The
20% Reserve Bank revises these weights annually to reflect changing
10% trading patterns.
0%
Queensland NSW NSW surface North & Wyoming Colombia South Africa Indonesia
140
Surface Underground Central Surface surface surface surface
Appalachia
B underground 120

100
FIG 4.7 - The percentage contribution of transport costs for coal
sold in the Japanese and European markets in 1995. (A) Japan, 80
(B) Europe.
60

The combinations of changes in environmental legislation and 40

increased difficulties in gaining mining permits in Europe and
North America have adversely affected the ability of companies
to open and operate mines in several nations on these continents.
As this has occurred, it has been necessary to import minerals
from other parts of the world to meet domestic needs.
MINERALS TRADE AND EXCHANGE RATES
Suppose that Australians decide to import goods or services
from Japan. Typically they must pay for these either in yen or
sometimes with a third currency such as the US dollar. They will
typically use their Australian dollars to buy these. The reverse
situation applies when Australian resource companies export
their ore, concentrate, metal or liquefied natural gas to Japan.
They usually want to be paid in Australian dollars. Japanese
customers will use yen to buy Australian dollars.
A nation (or company or individual) can obtain the foreign
currencies needed to make payments for imports in two ways:
• by exporting goods and services to other nations, thereby
earning the foreign currency needed to make the transactions;
and
• by attracting international investors to undertake new
investment in a venture in the nation (or owned by the
company or individual).
Any nation’s total payments to other nations must be equal to,
or balanced by, the total payments received from other nations.
There are recorded in the balance of payments accounts.
The exchange rates between one country’s currency and those
of its trading partners typically generate a balance of payments.
Where exchange rates are floating, as they have been in
Australia since December 1983, international payments will
always be in balance. Exchange rates adjust up and down
automatically to ensure that this takes place. Where they are
20
0
1970 1975 1980 1985 1990 1995 2000 2005
FIG 4.8 - Movements in Australia’s Trade-Weighted Index since
1970. Source: Reserve Bank of Australia, 2005.
Three phases stand out in this diagram:
• a rising currency associated with the period of the resources
boom in the early 1970s;
• a consistent decline in the value of the currency between
1973 and 1985 (the period in which members of the
Organisation of Petroleum Exporting Countries exerted a
major influence on the world economy); and
• a period of relative stability at new lower levels since 1985.
Currency weights for September, 2004, obtained from the
Reserve Bank’s web page, appear in Table 4.6. Of particular note is
the importance of Asian nations such as China and Japan in the
basket. It is useful to remember that the weights given to Japan
would have been minimal in 1960 and China did not feature in the
basket until the implementation of its ‘open door’ policy after 1978.
While movements in the Trade-Weighted Index are important, it
is more common to report movements of the Australian dollar
again the United States dollar. This is a reflection of the
importance of the US economy to the rest of the world. In the case
of minerals and energy, most prices are denominated in US$.
The profitability of mines and oil wells in any nation will be
affected significantly by the value of exchange rates, unless these
move up and down with mineral and energy prices. This has
tended to happen in Australia over time, though there are periods
where the correspondence has not applied. The case of gold
provides an interesting recent example.

Australian Mineral Economics 33

CHAPTER 4: TRADE IN MINERALS

Movements in exchange rates have fortuitously worked as a

TABLE 4.6
‘natural hedge’ against downward price movements in US
Currency weights in the Trade-Weighted Index of the Australian
dollar in September, 2004. Source: Reserve Bank of Australia
dollars. From time to time economists reconsider the question of
(2005). whether the Australian dollar is a ‘commodity currency’. Given
how important mineral exports have been as a percentage of the
Currency Percentage weight Australia’s total exports in the past 40 years, the Australian
Japanese yen 16.0616 dollar has tended to depreciate when mineral prices fall and
appreciate when they rise. Yet over a longer time period mineral
European euro 13.5177
producers should not take these movements for granted.
United States dollar 13.1603
Chinese renminbi 11.3042 REFERENCES
South Korean won 5.9748
Australian Bureau of Statistics, 2000. Australian mining industry 1998-99
New Zealand dollar 5.8800 (Australian Bureau of Statistics: Canberra) [online]. Available from:
UK pound sterling 4.7279 <http://www.abs.gov.au>. Date accessed: 8 May 2006.
Australian Bureau of Statistics, 2004. Mining operations Australia 2001-02
Singapore dollar 3.6558 to 2002-03 (Australian Bureau of Statistics: Canberra) [online].
Taiwanese dollar 3.1755 Available from: <http://www.abs.gov.au>. Date accessed: 8 May 2006.
Malaysian ringgit 3.0999 Australian Bureau of Statistics, various issues. International trade in goods
and services (Catalogue No 5368.0) (Australian Bureau of Statistics:
Indonesian rupiah 3.0208 Canberra) [online]. Available from: <http://www.abs.gov.au>. Date
Thai bhat 2.5910 accessed: 8 May 2006.
Crowson, P, 1998. Inside Mining: The Economics of the Supply and
Indian rupee 2.6227
Demand of Minerals and Metals (Mining Journal Books: London).
Hong Kong dollar 1.7666 Department of Industry and Resources, 2003. Western Australian Mineral
Canadian dollar 1.6244 and Petroleum Statistics Digest 2002-03 (Western Australian
Government: Perth) [online]. Available from: <http://www.doir.wa.
Saudi Arabian riyal 1.2299 gov.au/documents/mineralsandpetroleum/statsdigest0203.pdf>. Date
South African rand 1.1964 accessed: 8 May 2006.
Vietnamese dong 1.1311 Grubel, H G, 1981. International Economics, revised edition (Irwin:
Homewood).
PNG kina 0.9960 Lundgren, N-G, 1996. Bulk trade and maritime transport costs: The
Swedish krona 0.8788 evolution of global markets, Resources Policy, 22(1/2):5-32.
United Arab Emirates dirham 0.8614 Natural Resources Canada, 2006. [Online]. <http://www.nrcan.gc.ca>.
Reserve Bank of Australia, 2002. Developments in the Trade-Weighted
Philippine peso 0.7576
Index, Reserve Bank of Australian Bulletin, October, pp 1-6.
Swiss franc 0.6132 Reserve Bank of Australia, 2005. Statistics: Trade-Weighted Index
[online]. Available from: <http://www.rba.gov.au>.
For much of the past 20 years, movements in the gold price Ricardo, D, 1817. The Principles of Political Economy and Taxation (J M
have been largely in unison with the exchange rate. In most of that Dent and Sons: London).
period, spot gold prices have hovered around A$ 500. During Stewardson, R, 1992. Value adding in Australia, Australian Bureau of
1997, however, there was a dramatic downward movement in the Agricultural and Resource Economics National Agricultural and
US$ price of gold, due in part to the decisions of several Central Resources Outlook Conference (ABARE: Canberra).
Banks (including the Reserve Bank of Australia) to sell all or part US Energy Information Administration, 2006. [Online].
of their gold holdings. As the market price sank below US$ 300 <http://www.eia.doe.gov>.
per ounce, the Australian dollar also declined, but not at the same United States Geological Survey, 2006. [Online].
rate. Soon Australian dollar spot gold prices stood close to A$ 400 <http://minerals.er.usgs.gov/minerals>.
per ounce. Many gold producers were in trouble. Some switched World Trade Organization, various years. International trade statistics
[online]. Available from: <http://www.wto.org/english/res_e/statis_e/
to ‘high grading’ and most slashed exploration budgets to stay statis_e.htm>. Date accessed: 8 May 2006.
viable. Fortunately for local gold producers, the A$/US$ exchange
rate continued to fall and the A$ price of gold moved back towards
A$ 500 per ounce.

34 Australian Mineral Economics


Mineral Demand — The Theory in Practice
Peter Howie
Introduction
The Final-Product Demand Curve and the Level of Consumption
Mineral Resources and Derived Demand
Elasticity of Mineral Demand
Conclusions
INTRODUCTION
It is important to have information on current mineral
consumption, and its likely response to price and income
changes, government policies, economic development and
technological change. Because the demand for minerals is
multifaceted, it is also essential to have a good knowledge of the
fundamentals that affect mineral demand to analyse and forecast
output and price behaviour.
One way to categorise the demand for minerals is as derived,
created or historical. Industrial demand derives from the unique
physical and chemical properties of minerals that enable their use
in varied applications. Discussions of mineral demand
particularly recognise this characteristic. There is a strong link
between mineral uses and economic growth. This relationship is
likely to continue into the future.
Jewellery demand is created and requires constant promotion.
The growth in demand for jewellery is highly correlated with
demand for gold and other precious metals in the USA, Asia and
the Middle East. Consumers in the developed markets of the West
buy jewellery primarily for adornment and often for sentimental
reasons. In the developing markets of Asia and the Middle East,
they purchase it for investment, as well as adornment.
Investment demand is historical and relies on international
currency movements and inflation. The monetary demand for gold
and, to a lesser extent, other precious metals has derived value
from providing stability and security to overall investments.
This chapter is organised to permit an orderly presentation of
the basic topics of mineral demand separated into four parts. The
first presents the concept of final-product demand and introduces
some of the economics required to understand subsequent
sections. The second focuses on the derived demand for minerals
and the characteristics of such demand. The third introduces the
concept of elasticity and progresses with an in-depth
examination of the sensitivity of mineral demand to changes in
prices and income. This section also examines the effect of time
on mineral demand. The fourth section concludes.
THE FINAL-PRODUCT DEMAND CURVE AND
THE LEVEL OF CONSUMPTION
This section presents some necessary economic tools and generates
both individual consumer, as well as market final-product, demand
Australian Mineral Economics
CHAPTER 5
curves. Economists define a final product as a product that is
produced for its final user and not as a component of another good
or service. For example, a Nokia mobile telephone, a pair of gold
earrings and gold bullion used for investment are all final products;
but the copper wiring in the mobile telephone and the gold in the
earrings are intermediate products or inputs. To help with the formal
development of the final-product demand curve, let us introduce the
scenario that the Human Resource Director at Komatsu Australia is
interested in purchasing gold earrings for the upcoming year.
Since most goods are scarce and the Human Resources
Director cannot have everything that she wants, she must make
tough choices. The science of economics tells us that every time
a person makes a choice, something else must be given up. That
is, when the Human Resources Director purchases one good she
is giving up the opportunity to purchase another good or service
with the money she spends. Furthermore, economics provides a
set of tools that can help the Human Resources Director make
the best decision available. This set of tools is based upon the
philosophy of utilitarianism. The foundation of utilitarian
philosophy is:
Actions are right in proportion as they tend to
promote happiness; wrong as they tend to
produce the reverse of happiness (Mill, 1863).
In other words, utilitarian philosophy suggests that the Human
Resources Director makes decisions with the ultimate objective
of maximising her happiness, both intellectual and sensual.
Commonly people believe that choices they make are in the form
of answers to the questions: ‘Which and how many pairs of earrings
should I purchase?’ The answer is believed to be that the Human
Resource Director decides to purchase the pairs of earrings that she
likes the best as long as they are within her budget.
Economists suggest that such questions should be answered by
comparing all the costs, not only money costs but also the costs
associated with inability to do something else. Therefore, when
the Human Resource Director purchases earrings, economists
suggest that she compares all costs and benefits. Often, however,
it is difficult or impossible to list all the available purchase
options within a person’s budget. Luckily, economics provides a
simple way to approach this problem. It suggests that we break
the question ‘How many and which pairs of gold earrings
should the Human Resource Director purchase?’ into a series
of further questions.
37
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE

Before doing this, let us make two simplifying but realistic The Human Resource Director’s marginal benefit curve from
assumptions that help in discussing the answers: gold earrings (or any individual product or service) is identical to
1. The Human Resource Director budgets a certain amount of her individual demand curve for gold earrings. That is, the
money to buy gold earrings and she spends all of this demand curve for gold earrings shows the marginal benefits of
money either on gold earrings or on another product. gold earrings to her.
It is also possible to derive the market demand curve for gold
2. Benefits from the purchases are expressed in terms of earrings. Table 5.2 provides a simplified picture of the gold
money. This means that all benefits, both sensual as well as earrings market if there are only two consumers. At $130 per pair
intellectual, from the purchase of gold jewellery are of earrings, consumer A demands five pairs per period and
measured in terms of equivalent money value. consumer B demands six pairs per period. Therefore, the market
The questions to be asked are: demand for gold earrings at $130 is 11 pairs of earrings.
Similarly, at $100 per pair of earrings, consumer A demands six
• How much is the Human Resource Director willing to pay
pairs and consumer B demands eight pairs. Therefore, the market
for her first pair of earrings?
demand is 14 pairs. This procedure of generating the market
• How much is the Human Resource Director willing to pay demand is often described as ‘announcing a price and adding up
for a second pair? the individual quantities demanded at that price’. This procedure
• How much is the Human Resource Director willing to pay is the same whether there are only two consumers in a market or
for each subsequent pair of gold earrings? many millions.
Figure 5.2 provides a graphical representation of the market
This type of questioning examines the effects of changes in
happiness with each additional purchase. It allows us to demand for gold earrings outlined in Table 5.2.
determine the number of dollars the Human Resource Director
regards as equivalent to each pair of earrings. It is a direct TABLE 5.2
measurement of the benefits she receives from each pair. Individual and market demand.
As Table 5.1 shows, the Human Resource Director derives
Price Consumer A’s Consumer B’s Market demand
$300 worth of benefit from one pair of earrings, $550 from two
($/pair) demand demand
pairs, and so on. So she receives $300 of benefit from the first
pair of earrings, $250 from her second pair, and so on. The 160 4 4 8
benefits that a consumer receives from consuming the next unit 130 5 6 11
of a product is the ‘marginal benefit.’ 100 6 8 14
70 7 10 17
TABLE 5.1
40 8 12 20
Marginal and total benefits.
Pairs of earrings Total benefits ($) Marginal benefits ($) A’s Demand B’s Demand Market Demand
0 0 -
1 300 300 $/unit $/unit $/unit

2 550 250
3 754 204
4 918 164 130

5 1048 130 100

6 1148 100

For the Human Resource Director, marginal benefits are the Q/t Q/t Q/t
5 6 6 8 11 14
amounts of money that she is willing to pay to enjoy the
attributes of an additional pair of gold earrings. For example, the
marginal benefit from the third pair of earrings is $204. FIG 5.2 - Individual and market demand curves.
Table 5.1 also shows that, as she buys more and more pairs, the
benefits she derives from each additional pair will be less than It is important to understand why the market demand curve is
that from the previous pair. Therefore, the graph of her marginal drawn as it is. Along the demand curve only price is allowed to
benefits from earrings is downward sloping (see Figure 5.1). change. Income and the prices of related goods are held constant.
Furthermore, there are two independent reasons for the market
350 quantity demanded to fall as prices increase. One is that many
people will switch to a substitute good. If the price of gold
300
jewellery rises, some consumers will switch to platinum
Marginal benefits (dollars)

250 jewellery, others to silver jewellery. A second reason people buy

less when price rises is that they are not able to buy as much as
200 before. Incomes usually do not fluctuate with the price of an
individual product. Therefore, when the price of a product goes
150
up, it is not possible to buy as much as before unless we purchase
100 less of something else.
Similar to the market demand curve, the market supply curve
50
represents the behaviour of suppliers during a given time period.
0
The market supply curve shows the total number of units of a
0 1 2 3 4 5 6 good or service that sellers are willing to deliver to the market at
Pairs of gold earrings per period every possible price during a given period. Market supply curves
generally slope upward, indicating that sellers are willing to
FIG 5.1 - Marginal benefit curve. supply a higher quantity as the price rises.

38 Australian Mineral Economics


When the price of a good or service is such that the quantity
that buyers want to buy is the same as the quantity that sellers
want to sell, the market is in equilibrium. If consumers wish to
consume more than producers wish to produce at a given price,
there will be buying pressure and the quantity demanded will
exceed the quantity supplied. Prices will rise. Conversely, if
consumers wish to consume less than producers wish to produce,
there will be selling pressure and the quantity supplied will
exceed the quantity demanded. Prices will fall. Such changes
continue until equilibrium is achieved – quantity demanded
equals quantity supplied. The price that accomplishes this is the
equilibrium price and the corresponding quantity is the
equilibrium quantity.
Final-product demand and its determinants
Recall that the demand curve shows that if there is an increase in
the price of a product, consumers will purchase less of it, all
other things being equal. In other words, if price goes up,
quantity demanded will go down; if price goes down, quantity
demanded will go up. This is the law of demand. It indicates
that if there is an increase in the price of a product, then there
will be a leftward movement along its demand curve and vice
versa. Economists refer to movements along the demand curve as
changes in the quantity demanded.
It is important to realise that the demand curve by itself
isolates the impact of price on the quantity of a product
demanded. Because the law of demand is one-dimensional (that
is, it only examines the impact of quantity demanded caused by
changes in the price of the good and vice versa) it leaves out
factors that shift the demand curve. For example, the law of
demand cannot fully explain the increase in the price of gold
since September 11, 2001. That is because the quantity of gold
consumed and produced is not solely determined by its price.
One key to the higher gold price on the demand side lies in
changes of investors’ preferences for gold due to the decay of
global economic health, in particular that of the US economy
(Kitco, 2004). In the period following September, 2001 investors
became increasingly worried about the safety of their US
dollar-denominated money and there was an increase in the
preference to hold gold as an alternative.
In addition to growing investment demand for gold bullion,
gold jewellery demand also increased due to changes in
consumer tastes. Even with a 20 per cent increase in the price of
gold during 2003, the World Gold Council estimated that the
consumer demand for gold was up 12 per cent in tonnage terms
(or 30 per cent in dollar terms) (Humble, 2004; World Gold
Council, 2004a).
A change in the preferences of consumers (ie consumers of
gold jewellery) and investors who are consumers of gold bullion
is only one of several non-price factors that change the quantity
consumed. These non-price factors shift the demand curve. The
demand curve:
• shifts to the right if a non-price factor causes the quantity
consumed to increase; and
• shifts to the left if a non-price factor causes the quantity
consumed to decrease.
Other non-price factors that shift the demand curve include
level of income, prices of related goods, and expectations.
The level of income and prices of related goods are very
important to gold jewellery demand. A large proportion of the
21 per cent increase in gold jewellery demand in India during
2003, the world’s largest consumer of gold jewellery, was due to
higher rural income as a result of the year’s generally good
1. A futures contract on gold is an agreement to buy or sell a specific
amount of a gold at a particular price on a stipulated future date.
Australian Mineral Economics
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
monsoon (World Gold Council, 2004b). The increased demand
for 18 carat white gold in China during 2003 is believed to have
been stimulated by the high price of platinum, a substitute for
gold (World Gold Council, 2004b).
Expectations play a key role in investment demand. While
gold is a volatile investment, it provides good hedge against
inflation or a fall in the US dollar. Remember that gold
transactions are denominated in US dollars. Consider the actions
of speculators during the last half of 2003. Throughout this
period, they bet heavily that the price of gold would rise by
purchasing futures contracts on gold1. This purchasing trend
topped-out during the first week of September, 2003 when they
negotiated almost 123 000 contracts to buy about 12.3 million
ounces of gold. This was the largest historical weekly position in
the Commodity Futures Trading Commission data going back to
1983 (Fuerbringer, 2003).
MINERAL RESOURCES AND DERIVED DEMAND
So far in this chapter discussion has focused on the consumer
demand for final goods and services. But most minerals are not
final goods. While consumers demand precious metals and gems
as final goods, these only account for a small fraction of total
mineral demand. The main use of minerals is as inputs for final
goods and services. Therefore, the demand for most minerals is
derived from the demand for the final goods and services that
they produce. Economists describe it as a derived demand. For
example, the demand for copper in mobile telephones is derived
from the demand for mobile telephones. Consumers of mobile
telephones are not concerned about which inputs are used as long
as the mobile telephone meets their needs.
The mineral demand curve
There is a clear relationship between final-product demand and
the derived demand of a mineral to make these final products.
Recall that determining final-product demand involves the
ultimate objective of maximising a consumer’s happiness
determined by the prices of goods and by the income available to
purchase them. By contrast, for our mobile telephone
manufacturer, who requires inputs for its production, mineral
demand is a special case of demand in which the purchased
goods are the inputs for production.
As a result, the demand for minerals is linked closely with a
firms’ production processes. Our firm’s mobile telephone
production process, and its demand for copper, expresses a
relationship between its inputs and its outputs. Economists
formally represent this production relationship by the
production function (see Chapter 2).
The production function is a non-monetary relationship that
correlates physical inputs to physical outputs. Prices and costs
are not considered. A typical production function for a firm with
only one variable input, say copper, and a set level of fixed inputs
appears in Figure 5.3. In this example, fixed inputs (those inputs
whose quantities cannot be readily changed in an effort to alter
the rate of output) include pieces of equipment and machinery,
the factory space available for production, the know-how of
managerial personnel, and all labour. The vertical axis shows the
total output and the horizontal axis shows the units of copper
employed. All points above the production function are
unobtainable with current technology, all points below are
technically feasible, and all points on the function show the
maximum quantity of output obtainable at the specified levels of
inputs. From the origin, through points A and B, the production
function is rising, indicating that as additional units of copper are
used, the quantity of mobile telephones produced are increasing.
From the origin to point A, as the firm uses additional units of
copper, the number of mobile telephones produced increases at an
increasing rate. The increase in output generated by adding an
39
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
Quantity of mobile
telephones per time period
B
A 1.
Units of copper
per time period
X The value that copper contributes to the mobile telephone
Y
APP
MPP Units of copper
per time period
Stage 1 Stage 2
FIG 5.3 - The production function.
additional unit of the variable input is called the marginal
physical product (MPP). For the mobile telephone manufacturer,
MPP is the increase in output of mobile telephones caused by
increasing the input of copper by one unit. As the number of
mobile telephones is increasing at an increasing rate from the
origin to point A, the firm’s MPP is also increasing as shown by
the increasing MPP of copper from the origin to point X. The
average amount of telephones generated by each unit of copper
employed – the average physical product (APP) – is rising along
the production function between the origin and point A.
Point A defines the starting point beyond which the number of
mobile telephones increases at a decreasing rate when additional
units of copper are employed. This corresponds to declining
MPP of copper beyond point X.
Beyond point B the average number of telephones generated
by each additional unit of copper employed starts to decrease.
This trend is shown by the decline of the APP curve beyond
point Y.
To simplify this interpretation of a production function, it is
common to divide its range into two stages. In Stage 1 (from the
origin to point B) the average number of mobile telephones
produced by the variable input (here copper) and the fixed inputs
is rising reaching a maximum at point B. Because the average
number of mobile telephones generated by both the variable and
fixed inputs is increasing throughout Stage 1, the firm will
always try to operate beyond this stage. It turns out that in Stage
1, fixed inputs are under utilised.
In Stage 2, the output of mobile telephones increases at a
decreasing rate. That is, both the additional mobile telephones
generated by each additional unit of copper used and the average
amount of mobile telephones generated by each unit of copper
employed are decreasing. However, the average amount of
mobile telephones generated by the fixed inputs is still rising. It
turns out that the optimum copper/mobile telephone combination
will be in Stage 2. Therefore, a profit-maximising firm will
always operate somewhere in Stage 2. When referring to the
2. Arguing more broadly the outcome depends on the overall market
for mobile phones, on the degree of competition therein, on profit
margins, and on copper’s share of the costs. The rise in copper prices
could easily be absorbed in profit margins.
40
MPP curve from now on, our focus is on the downward sloping
portion in Stage 2.
The next step is to determine how many units of copper our
profit-maximising firm will employ. The answer is
straightforward: our firm will employ any unit of copper that
produces greater value than it adds in cost. That is, the firm will
use an additional unit of copper when the benefits from it are
greater than its costs. For simplicity let us assume that:
the added cost equals the market price of the copper (which
implies that the buyer of copper is a price taker); and
2. the price of mobile telephones is constant.
manufacturer depends on two things:
• how much the output of mobile telephones increases by
adding an additional unit of copper; and
• the extra revenue that each additional mobile telephone
brings to the firm.
In economics, the value that an extra unit of variable input
contributes is called the marginal revenue product (MRP), as
opposed to the MPP. The MRP of copper is simply the added
revenue or benefit of employing an extra unit of copper. For our
mobile telephone manufacturer, this benefit equals the MPP of
copper multiplied by its market price.
The cost of the copper, by the above assumption, equals its
market price. Therefore, the mobile telephone manufacturer will
employ additional units of copper until the benefit that an extra
unit of copper contributes (the MRP) equals the market price or
cost of an extra unit of copper.
A numerical example clarifies this idea. Suppose the mobile
telephone company, Nokia, has a factory in Indonesia. It pays
A$ 12 per kilogram for copper wiring. Suppose Nokia receives
A$ 12 for each telephone, and adding another kilogram of copper
will allow it to make two more mobile telephones per hour. Is it
worthwhile to add another kilogram of copper? Using the above
rule, the extra value to Nokia is 2 × A$ 12 or A$ 24. The extra
cost to Nokia of another kilogram of copper is A$ 12. Hence, it
is in Nokia’s interests to add more copper. After this kilogram of
copper is added, Nokia finds that adding another kilogram of
copper will add only one more mobile telephone. Now the
company is indifferent to adding an extra kilogram because to
generate an extra A$ 12 of income costs A$ 12. From now on,
Nokia will not use additional units of copper because the extra
value that they generate is less than their price.
An important characteristic of the MRP curve of a mineral is
that it corresponds to a manufacturer’s demand curve for it. Our
firm’s mineral demand curve identifies the amount of copper it
chooses to employ at different prices, holding everything else
constant including the price of mobile telephones.
Now let us examine the market demand curve for copper.
Unlike final-product market demand curves, market mineral
demand curves are generally not the horizontal sum of individual
firm mineral demand curves. This is because of the derived
nature of the demand for minerals.
Changes in the market price of copper bring about changes in
the cost of producing mobile telephones. When all mobile
telephone manufacturers experience this, there are changes in the
quantity of mobile telephones available in the market and their
price. The price of mobile telephones must be held constant for
horizontal summing to be appropriate. If the price of copper
increases, then the market price of mobile telephones will
increase and most likely vice versa2. When this ‘final-product
effect’ is taken into account, the copper demand curve for each
individual mobile telephone manufacturer will be steeper. This
market demand curve will have a steeper slope than the one
obtained from the unmodified individual firm copper demand
curves (Campbell, 1985).
Australian Mineral Economics

We now have a view of one half of the market for minerals –
mineral demand. We now need briefly to look at the supply side
of the minerals market3. We can once again use the mobile
telephone producer example and attempt to put ourselves in the
positions of the mineral suppliers – the copper producers. If the
price of copper increases, producers are willing to supply more
copper to the market. As a result, the mineral supply curve is
positively sloped. That is, at a higher price there will be a greater
supply of copper. If this supply information is combined with the
information on mineral demand we would get a diagram such as
Figure 5.4, which describes the achievement of equilibrium in
the mineral market.
$/unit
S
P*
D
Q/period
Q*
FIG 5.4 - Equilibrium in a mineral market.
This analysis is similar to our earlier supply-demand analysis
for gold earrings. The market tends toward the equilibrium price
where mineral supply equals mineral demand. At any other price
there will be a shortage (price too low) or a surplus (price too
high) and there will be adjustments in the price to bring the
market to equilibrium.
Shifts of the mineral demand curve
We have already discussed factors that shift the final-product
demand curve in the section above. There is a parallel discussion
for the factors that shift the mineral demand curve but some of
these are different from the factors that shift the final-product
demand curve. These different factors reflect the derived nature of
the input demand curve. Three seem particularly important:
• a change in demand for the final product,
• a change in technology, and
• a change in the mix of inputs.
First, consider a change in consumer demand for the final
product. As one might expect, there is a direct positive
relationship between final-product demand and mineral demand.
That is, an increase in the demand for mobile telephones will
increase the demand for copper. On a graph, this translates to a
rightward shift of the mineral demand curve. A decrease in the
demand for mobile telephones will reduce the demand for
copper. On a graph, this translates to a leftward shift of the
mineral demand curve.
Second, contemplate the impact of a change in technology.
The production function in Figure 5.3 assumes a constant state of
technology in both the minerals industry and the final product
industry. But within the minerals industry, changes in technology
have led to better capital equipment and processes. They have
also reduced non-productive work hours. For example, a major
innovation in the copper industry has been in the solvent
3. This will be examined in more detail in Chapter 6.
Australian Mineral Economics
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
extraction electro-winning (SX-EW) process. This has allowed
the recovery of copper from mine tailings, as well as a higher
percentage of metal to be ultimately recovered from orebodies.
The process cut the tonnes of waste per tonne of ore mined by
over 35 per cent in 1995 in comparison to 1970 (Olewiler, 2002).
However, the end result was a rightward shift in the copper
supply curve, which caused the quantity demanded of copper to
increase. Therefore, a change in technology within the copper
mining industry will only shift the copper supply curve and as a
result increase the quantity of the copper demanded (see Figure
5.5). But note that this change in technology has not shifted the
copper demand curve.
$/unit S1
S2
D
Increased
Q/period
mineral
demand
FIG 5.5 - Shifting supply curves and increased mineral demand.
In contrast to technological change in copper mining,
technological change in a manufacturing process that uses
copper as an input will cause a shift in the copper demand curve.
Two types of technological changes in manufacturing may cause
this shift:
• the refinement and improvement of existing processes, and
• the development of new products.
The steel smelting industry provides a good example of
refinement and improvement technological change. During the
early 1960s, technological innovation in the injection of
pulverised coal into blast furnaces reduced coking coal rates by
36 per cent per tonne of steel. By the beginning of the 1990s
injection rates of coking coal had declined by an additional
15 per cent per tonne (Mitchell, undated).
When technological change permits the use of a smaller
quantity of mineral inputs to obtain a given level of output, the
final-product production function (here the production function
for steel) shifts leftward as shown in Figure 5.6 and the mineral
demand curve will shift to the left.
Quantity of steel output
per time period
Production Production function
function after before technological
technological change
change
Units of coal
per time period
FIG 5.6 - Technological change shifting final-product production
function.
41
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
Even though refinement and improvement technological
change directly reduced the demand for coal in the production
of steel, it also indirectly increased the demand for coal in steel
production. An important result of refinement and improvement
technological change is its ability to lower the cost of delivering
an extra unit of steel to the market. This will increase the
quantity of steel demanded which will also increase the demand
for coal. Other things being equal, the coal demand curve will
shift to the right. As a consequence, the final result of refinement
and improvement technological change on a specific mineral’s
demand curve is not always easy to assess in an accurate fashion.
Technological change that develops new products can either
increase or decrease the demand for a mineral. Consider some of
the ways this is affecting the demand for copper. Optical fibre
cables, which are now used widely in telecommunications, have
replaced huge tonnages of copper wire. Comparisons indicate
that an optical fibre can carry over a quarter of a million times
more information than a similarly sized copper wire (Dulay,
2004). By contrast Power Economics (2003) estimates that new
wind turbine projects to meet Kyoto Protocol targets should
increase copper demand in the European Union by an annual
10 000 tonnes4.
The third factor that causes the mineral demand curve to shift
is a change in the price of other inputs, which causes a change in
the mix of the inputs used. The effect of a change in the price of
one mineral, say aluminium, on the demand for another mineral,
say copper, is also difficult to estimate in an accurate way.
Aluminium and copper are often used together in coaxial cable
with a copper centre conductor and aluminium shield. In this use
they are complements (or complementary inputs). In other cases,
aluminium is a substitute for copper. This occurs in several
applications.
When aluminium is a complement of copper, a decrease in the
price of aluminium causes a rightward shift in the mineral
demand curve for copper. An increase in the price of aluminium
causes a leftward shift in the copper demand curve.
Price changes for a substitute mineral are more complicated.
There is a direct effect as well as an indirect effect of the price
change. A higher price of aluminium destined for the electrical
industry, relative to the price of copper, results in a direct
increase in the use of copper because copper will be substituted
for aluminium. However, the higher price of aluminium may
cause copper use to decline indirectly because copper may not be
able to replace all aluminium completely. The indirect effect of
the increase in the price of aluminium is caused by the increase
in the cost of producing the final product, which in turn leads to
lower production and less demand for both aluminium and
copper. The final result of a price change for a substitute mineral
depends on which effect is larger, the direct or indirect, and
varies from product to product.
ELASTICITY OF MINERAL DEMAND
When there are price movements along the demand curve as well
as shifts in demand, it is important to have an estimate of the
magnitude of those changes. Economists use the concept of
elasticity of demand to indicate the quantitative impact of the
factors affecting demand. Even though it is a simple concept,
elasticity is one of the most powerful devices that economists
use. It is simple because it is no more than a measure that tells
how sensitive one variable is to another. It is powerful because of
the way economists make use of it in analysing how benefits and
costs change as a result of small changes in specific variables
4. An average one-megawatt wind turbine contains 4.4 tonnes of copper
(Power Economics, 2003).
5. An alternative way to define own-price elasticity is by placing a
negative sign before the right-hand term in the formula. This converts
the magnitudes to positive values.
42
such as prices and income. The concept of elasticity can, for
example, help answer questions such as:
• Will an additional unit of output make our firm more or less
profitable?
• Will this consumer’s happiness rise or fall if consumption
changes slightly?
There are three main types of elasticity of mineral demand:
• own-price elasticity of demand, which measures how the
quantity demanded of a mineral changes if its price changes;
• income elasticity of demand, which measures how the
quantity demanded of a mineral changes if income changes;
and
• cross-price elasticity of demand, which shows how the
quantity demanded of one mineral changes if the price of
another mineral changes.
The following discussion of elasticity is separated into two
parts because elasticity is determined, in part, by the time period
involved. After further discussion of the concepts of elasticity of
mineral demand, part one applies the concepts of elasticity to the
short run. Part two then shows how the elasticities of mineral
demand change over time and presents how economists use
long-run elasticities.
The short run is a period in which market conditions are
considered fixed. Campbell (1985) argues that a firm’s lease, its
existing production capacity, employment contracts, and several
other operating conditions are inflexible in the short run.
The long run has no such fixed costs and conditions –
everything is free to change. Given more time, manufacturers can
develop new strategies for adjusting production processes such as
substituting aluminium for tin. Also consumers can adjust
personal consumption expenditures such as by purchasing motor
cars that either run on natural gas or are hybrid in their model of
operation. An important consideration between the short- and
long-run is that the definitions do not include a definite time
period. They are based on the degree of flexibility that firms have
to change inputs and consumers have to change their lifestyles.
A consequence of these definitions is that the relevant time
period that distinguishes the short run from the long run will vary
from industry to industry.
Own-price elasticity of mineral demand in the
short run
The own-price elasticity of demand of a mineral is the
percentage by which quantity demanded changes if its price
increases by one per cent, all other things being equal. The
simple formula is:
own-price elasticity of demand =
per cent change in quantity demanded
per cent change in price
Own-price elasticity of demand is negative because of the
inverse relationship between price and quantity demanded as
indicated by the law of demand5. When a percentage reduction
in price leads to a less than proportional increase in quantity
demanded, demand is inelastic, and when the quantity demanded
changes proportionally more than the change in price, demand is
elastic. Inelastic own-price elasticity of demand is defined as a
value of greater than minus one, and elastic own-price elasticity
of demand is a value of less than minus one.
Generally, demand for luxury goods is price elastic. The demand
for essential products such as petrol and food is usually inelastic.
People generally buy these products even if the price goes up.
Interestingly, demand for consumer goods such as household
appliances and motor vehicles also have a high price elasticity, since
people can easily find substitutes or do without them.
Australian Mineral Economics
 CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE

Gold Jewellery: Petrol:

Elastic Demand Inelastic Demand
$/unit $/unit

small percentage
change in quantity
large percentage change demanded large
in quantity demanded percentage change
small percentage change in price
in price
P2 P2
P1 P1
DAu
DPetrol
Au2 Au1 QAu/period Pet2 Pet1 QPetrol/period

FIG 5.7 - Sensitivity of mineral demand to price changes.

Figure 5.7 illustrates two demand curves, one for gold
jewellery and the other for petrol. From the diagram, when the
price of gold jewellery rises from P1 to P2, the per cent change in
the quantity demanded of gold jewellery – from Au1 to Au2 – is
greater than the per cent change in price. Therefore, gold
jewellery is own-price elastic at point Au1. Conversely, when the
price of petrol rises from P1 to P2, the per cent change in the
quantity demanded of petrol – from Pet1 to Pet2 – is less than the
per cent change in price. Therefore, petrol is own-price inelastic
at point Pet1.
Before discussing the determinants of own-price elasticity of
mineral demand, it is important to understand own-price
elasticity in an intuitive way. Suppose our mobile telephone
manufacturer spends a part of its budget on copper wiring. If the
price of copper wiring rises by five per cent, the manufacturer
may buy less. But does he or she buy six per cent less or just two
per cent less? In the first case, demand will be own-price elastic.
In the second it will be own-price inelastic. Clearly in the case of
petrol, and most likely copper wiring, a rise of five per cent in
the price of petrol would not cause a buyer to reduce his
consumption of petrol by more than five per cent. That is, there is
a small effect of a price change on rates of consumption. A brief
summary of these cases is as follows:
In contrast, a higher gold price will cause a person to buy
fewer pairs of new gold earrings or other jewellery if their
own-price elasticity of gold is elastic. A rise of five per cent in
the price of gold jewellery will cause the consumer to reduce
consumption of gold jewellery by more than five per cent.
A good way to examine the factors affecting the own-price
elasticity of the mineral demand curve is to use concepts
developed in the four Hicks-Marshall laws of derived demand –
named after their originators, John Hicks and Alfred Marshall. In
his classic treatise, Principles of Economics (published in 1890),
Alfred Marshall formulated four rules about the determinants of
own-price elasticity of derived demand. In re-examining
Marshall’s four rules, Hicks (1966) described own-price
elasticity of derived demand for labour in terms of
substitutability of inputs and own-price elasticity of final-product
demand6. While full statements of the four laws are complex,
brief and simplified versions of them yield valuable insights into
the determinants of the own-price elasticity of mineral demand.
The Hicks-Marshall laws conclude that own-price elasticity
of mineral demand, of say copper will be relatively high when:
• own-price elasticity of demand for the final product is
relatively high;

Copper wiring Petrol

• it is relatively easy to substitute other inputs for copper;
Case One Case Two Likely case • own-price elasticity of supply of other production inputs is
relatively high; and
Price rise 5% 5% 5%
Quantity fall 6% 2% Say 1%
• copper accounts for a relatively large share of total costs of
producing the final product.
Own-price elasticity -1.2 -0.4 -0.2
of demand Each of these laws will now be examined in turn. The first
Hicks-Marshall law states that own-price elasticity of mineral
Result Elastic Inelastic Highly
demand demand inelastic
demand will be elastic when own-price elasticity of demand for
demand the final product is relatively high. Economists traditionally
examine the response of the mineral demand to a final-product
price change by assuming that the proportions of inputs are fixed.
The demand curves for most minerals are own-price inelastic – When the demand for the final product is own-price elastic, say
that is, steeply sloped – if considering the short run. This is -1.5, then the demand for the final product changes 50 per cent
because manufacturers and consumers who use minerals as more proportionally than the price. However, when the demand
inputs are constrained from changing by their existing plants, for the final product is own-price inelastic, say -0.5, then quantity
equipment, and vehicles. demanded of the final product changes only half as much
proportionally as the price. Therefore, when the demand for a
6. Hicks (1966, pp 241-247) provides a complete mathematical final-product is own-price elastic, there will be a greater
derivation of the four rules of derived demand. reduction in the use of all inputs.

Australian Mineral Economics 43

CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
Elastic Supply
$/unit
S
P2
P1
D D‘
Q1 Q2 Q/period
FIG 5.8 - Own-price elasticities of supply.
A good example is the use of silver in jewellery and dental
filling alloys. The estimated own-price elasticity of demand for
silver jewellery is highly price elastic, (Venkatesh, 2002; GFMS
Limited, 2004) whereas the own-price elasticity of demand for
dental services is price inelastic (Eriksson, 2003; Grytten, 2003;
Manning and Phelps, 1978)7. As the own-price elasticity of
demand for silver jewellery is relatively high, an increase in the
price of silver jewellery will result in a large reduction in the
quantity of silver jewellery demanded. This will cause a large
reduction in the supply of silver jewellery and in turn cause a
large reduction in the use of silver. Therefore, an increase in the
price of silver jewellery will result in a large reduction in the
quantity of silver demanded for silver jewellery. By contrast, an
increase in the price of silver dental fillings will result in only a
small reduction in the quantity of silver demanded for silver
dental filling alloys.
The second Hicks-Marshall law states that own-price
elasticity of mineral demand is elastic when it is relatively easy
to substitute other inputs to replace the mineral under
consideration. One measure of substitutability between inputs
considers how much input proportions change when the price of
one of the inputs, say copper, changes, holding output of the final
product fixed. When it is easy to substitute other inputs for
copper, a small change in relative price of copper will cause a
large change in the proportion of the inputs used. On the other
hand, when it is difficult to substitute other inputs for copper, a
small change in the price of copper is probably not going to
cause a firm to replace a unit of copper with a unit of another
input.
Decisions about the substitution between a mineral and other
inputs depend on two general factors, technology and relative
prices. Different combinations of inputs will produce different
levels of output. How a manufacturer combines copper and the
remaining inputs reflects the technology available.
An example of the second Hicks-Marshall law is naturally
occurring rutile being substituted by synthetic rutile (which is
produced from ilmenite) in the titanium dioxide white pigment,
metal and welding-rod coatings markets (Consolidated Rutile
Limited, 2004). As it is relatively easy to substitute synthetic
rutile for naturally occurring rutile, a price increase in naturally
occurring rutile could result in a large reduction in the quantity
demanded of it.
7. In their study of the USA, Manning and Phelps estimated that
own-price elasticity for dental visits was -0.7.
44
Inelastic Supply
$/unit
P2
P1
D D
Q1 Q 2 Q/period
The third Hicks-Marshall law states that own-price elasticity
of mineral demand will be relatively high when the supply of
other factors of production is relatively own-price elastic. It is
worth digressing for a moment to discuss own-price elasticity of
supply. The responsiveness of supply to changes in price of a
good or service is its own-price elasticity of supply as illustrated
in Figure 5.8. The definition of own-price elasticity of supply is
the percentage by which a product’s quantity supplied would
change if its price increased by one per cent, all other things
equal. The simple formula is:
own-price elasticity of supply =
per cent change in quantity supplied
per cent change in price
When supply is relatively inelastic, a change in demand affects
the price more than the quantity supplied. The reverse is the case
when supply is relatively elastic – a change in demand is met
with a small change in market price.
The Hicks-Marshall third law examines the case with which a
mineral can be substituted by other inputs. From the discussion
of the second Hicks-Marshall law it can be seen that substitution
between a mineral and other inputs generally depends on
technology and relative prices. However, substitution of one
mineral for another can also be affected by spare capacity in an
input industry as well as the level of stocks or inventories of the
other inputs. If there is plenty of spare capacity with the
availability of another input or if the stocks of this input are high,
a manufacturer will find it more beneficial to substitute this other
input for copper, all other things being equal.
Spare capacity and high level of stocks correspond to elastic
supply. If the price of copper increased and the supply of another
input, say molybdenum, was own-price elastic, the increase in
demand for molybdenum would have little effect on its price.
A manufacturer may significantly increase his profits by using
more molybdenum and less copper.
However, if the supply for the other input, say aluminium, was
inelastic, an increase in demand for aluminium would
substantially increase its price and the additional quantity of
aluminium supplied to the market would be small. In this case, a
manufacturing firm would not increase profits by increasing its
use of aluminium and decreasing its use of copper.
A good example for the third Hicks-Marshall law is the
situation of heavy machinery manufacturing in the Former Soviet
Union (FSU). One of the impacts of inefficient Soviet central
Australian Mineral Economics

planning was that industry became heavily dependent on energy
priced far below world levels (Platts, 2004; European Bank of
Reconstruction and Development, 2002). Since the start of
transition, energy consumption has fallen principally as the result
of the severe decline in output in the early 1990s. For example,
Kazakhstan’s net energy consumption decreased by 45 per cent
between 1992 and 1998 (United States Energy Information
Administration, 2003). At present there is abundant excess
capacity in electricity generation in many former republics of the
former Soviet Union. As a result the supply of electricity is quite
elastic. If there was a large increase in demand for electricity in
the FSU, it would result in a large increase in electricity use and
a relatively small increase in price.
By contrast, when the supply of electricity is relatively
inelastic, as recently in Australia, an increase in the demand
drives up its price by a relatively large amount but has a
relatively small effect on the quantity of electricity used by
industry (Brennan, 2002). When this occurs, the increase in the
price of electricity limits the amount of additional electricity that
can be used as a substitute for a mineral. Therefore, a
manufacturer in the FSU may experience elastic demand for
some minerals whereas a manufacturer in Australia may
experience inelastic demand for the same minerals.
The fourth Hicks-Marshall law states that own-price elasticity
of demand for a mineral is relatively large when the mineral
accounts for a relatively large share of total costs. In this situation,
a price increase of the mineral will have a large effect on a
manufacturer’s costs and therefore a large effect on the price of the
final product. With this large increase in the price of the final
product, the decrease in the quantity of the final product
demanded would be large and, consequently, the reduction in the
mineral’s use would also be large, all other things being equal.
Therefore, an increase in a given mineral’s share of total costs will
result in a higher own-price elasticity of demand for this mineral.
The use of aluminium and palladium in motor cars explain the
ideas in the fourth Hicks-Marshall law. In 2003, a typical family
car contained 124 kilograms of aluminium and between three
and four grams of palladium (Corbett, 2003; Johnson Matthey,
2004). If palladium costs account for 0.25 per cent of total
automobile costs, a doubling of its price will only increase the
total cost of an automobile by about 0.25 per cent. On the
contrary, if aluminium costs account for 1.5 per cent of total
costs, a doubling of its price will increase total costs by 1.5 per
cent. As a result, aluminium has a higher own-price elasticity of
demand vis-à-vis palladium for the automobile industry8.
Income elasticity of mineral demand in the short
term
Income elasticity of demand is a measure of the sensitivity of
demand to changes in consumers’ income. It is the percentage by
which demand will change if consumer income changes by one
per cent, all other things being equal. Its simple formula is:
income elasticity of demand =
per cent change in quantity demanded
per cent change in income
For most products, as income rises, demand increases. Goods
and services with income elasticities more than one are called
income elastic. Many minerals possess relatively high income
8. Palladium and platinum are close substitutes for one another in the
production of automobile capacitors. A rise in its price has often
caused massive substitution between these two metals. This is not the
effect, however, described in the above example.
9. Relevant empirical studies show that non-monetary demand for gold is
income elastic and the demand for residential electricity is strongly
income inelastic (eg Bernard et al, 1996; Veneroso and Costelloe, 2002).
Australian Mineral Economics
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
elasticities of demand. These are a direct result of high income
elasticities of demand for the final products in which minerals
are used as inputs. These final products – things such as motor
cars, houses and refrigerators – are items that consumers are
more inclined to buy during economic upturns. Purchases of
these durable goods (often known also as discretionary goods)
usually increase when consumers feel wealthier.
However, some minerals such as crude oil and industrial
minerals have income elasticities between zero and one. Such
goods are called income inelastic. The demand for these and
other necessities tend to be relatively less income elastic than the
demand for discretionary products. Consider, for instance the
demand for residential electricity as compared to gold jewellery9.
Purchasing gold jewellery is more discretionary than purchasing
electricity for home use. Accordingly, we expect the demand for
electricity to be income inelastic and the demand for gold
jewellery to be income elastic (see Figure 5.9).
Quantity Quantity
demanded demanded
Normal good: Normal good:
income elastic income inelastic
Income/period Income/period
FIG 5.9 - Income elasticities of demand.
Resource economists commonly apply the concept of income
elasticity of demand to analyse the effect of changes in national
income levels – using measures such as Gross Domestic Product
(GDP) – on the demand for minerals. For example, how do
changes in national income influence iron ore demand? The
year-to-year instability in mineral demand is due, in part, to the
strong link between it and the state of countries’ economies,
especially investment expenditures. Large fluctuations in
investment are often considered the driving force of business
cycles – fluctuations of GDP over time. Expansions and booms
are generally characterised by high levels of investment,
whereas, in troughs there are generally low levels of investment.
During economic downturns mineral demand is commonly low
as investment spending on buildings and structures,
transportation equipment, heavy machinery and consumer
durables has fallen away. Conversely, mineral demand tends to
be high during economic upturns as the consumption of capital
goods and consumer durables swells. This pattern suggests that,
at least in the short term, mineral demand in most developed
countries is highly income elastic.
For mineral producing countries, such as Australia, a high
short-term income elasticity of mineral demand has notable
implications. Generally, this causes the mineral demand curve to
shift sharply over the business cycle prompting mineral output,
prices, revenues and profits to fluctuate greatly (Pei and Tilton,
1999). The resulting volatility can have significant impact on a
country’s management of its macroeconomy because of sudden
swings in exchange rates and in tax revenues from the mining
sector (Humphreys, 2000).
In addition, because Australia is a commodity exporter and an
importer of consumer durables and investment goods, its
economy does not always conform to the general country-level
models. Australia’s mineral sector is to a great extent linked with
the manufacturing, construction and transportation sectors of
other countries. Gruen and Shuetrim (1994) found that a one per
cent change in GDP levels in OECD10 member nations led to a
45
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
1.2 per cent increase in Australian GDP. As a result, the linkage
between income levels and the demand for minerals in the case
of Australia should be examined at a multi-country scale.
Cross-price elasticity of mineral demand in the
short term
It is also possible to use the concept of elasticity to indicate the
effect of price changes in related products. The relevant concept
here is cross-price elasticity of demand. For example, the
cross-price elasticity of demand relates the percentage change in
quantity demanded for a mineral with the percentage change in
the price of another product, all other things being equal. The
simple formula is:
cross-price elasticity of demand =
per cent change in quantity demanded of good ' A'
per cent change in price of good ' B'
The cross-price elasticity of demand can be positive or
negative, depending on whether we observe a change in the price
of a substitute or a complement. If two minerals are substitutes,
an increase in the price of one will increase the demand for the
other, so the cross-price elasticity would be positive. For
example, gold and platinum are substitutes in the jewellery
market. This is shown by the six per cent increase in the
consumption of gold jewellery in China during 2003 which was,
in part, caused by the 40 per cent increase in the price of
platinum (Bailey, 2004; Johnson Matthey, 2004; World Gold
Council, 2004a)11. Figure 5.10 illustrates a positive cross-price
elasticity of demand for gold with respect to platinum.
By contrast, if two minerals are complements, an increase in
the price of one will reduce the demand for the other; therefore,
the cross-price elasticity would be negative. The demand of
18-carat white gold, which is an alloy made by mixing 75 per
cent gold with 25 per cent other metals, such as silver and
$/unit
Price of palladium, a Price of platinum, a
complement mineral, substitute mineral, rises.
rises. Demand for gold Demand for gold increases.
decreases. Negative Positive cross-price
cross-price elasticity of elasticity of demand
demand
D1 D2
D0
Quantity of gold/period
FIG 5.10 - Cross-price elasticity of demand.
10. The Organisation for Economic Co-operation and Development
(OECD), which has about 30 member nations.
11. In 2003, China accounted for approximately 18 per cent of global
demand for platinum (Johnson Matthey, 2004).
12. However, over the long run, minerals also exhibit some cross-price
responsiveness because certain equipment choice decisions include
the consideration of minerals, especially fuel minerals. An example
is the decision to use oil heaters rather than natural gas water heaters.
Thus, some equipment choices are based on more than just the price
of a single mineral and result in measurable long run cross-price
elasticities.
46
palladium, is sensitive to the prices of gold, silver, and palladium
(Gillett’s Jewellers, 2004). Therefore, if the price of palladium
rose by 50 per cent, the demand for gold would decrease, as is
illustrated in Figure 5.10.
Cross-price elasticity of demand is a common analytical tool
to identify markets in anti-trust inquiries. By examining the
cross-price elasticity of demand it is possible to measure how
much a firm can raise its prices without consumers defecting to
some substitute and other firms altering their production
processes and supplying similar products at lower prices. If there
are close substitutes, then the price increase initiated by the firm
will lead to a large reduction in its sales and its profits will fall as
a consequence.
The 1956 US anti-trust case against Du Pont is a classic
example of the use of cross-price elasticity of demand. Du Pont
argued that cellophane was not a separate market, since, at
prevailing prices, there appeared to be a high cross-price
elasticity of demand between it and aluminium foil, wax paper
and polyethylene. This meant that what seemed to be a single
seller or monopoly of the cellophane market looked like a much
more modest share of something that might be called ‘the
wrappings market’. The court found that Du Pont did not have
monopoly power despite control of 100 per cent of the
cellophane market because cellophane made up only 20 per cent
of the wrappings market (Cueller, 2000).
Elasticity of mineral demand in the long run
Because minerals are inputs in durable and non-durable final
products – from construction of buildings to the manufacture of
prescription drugs – it is important to discuss the effect of
adjustment time on the elasticities of mineral demand. Because
economists generally examine only long-run own-price and
income elasticities of mineral demand12, the discussion in this
section is limited to these concepts.
A significant percentage of industrial minerals is used in
non-durable final products. These include clays in animal
feedstuffs and medicines, as well as limestone in paper.
Generally, for non-durable final products, the longer the time
that buyers have to adjust, the larger will be the response to a
price change. Accordingly, the demand for such goods will be
more own-price elastic in the long run than in the short run.
Figure 5.11 illustrates the short and long run demand for a
non-durable good.
A non-durable final product worth highlighting is petrol. To
the extent that petrol has no short run substitutes, the short run
demand is relatively own-price inelastic. The short run effect of
price changes on the quantity demanded will work through
discouraging people from purchasing an additional car or driving
to work. Over time, however, they will purchase more
$/unit
long run
demand
short run
demand
Q* Q/period
FIG 5.11 - Short and long run demand for a non-durable product.
Australian Mineral Economics

fuel-efficient automobiles and find alternative means of
transportation. Accordingly, the demand for petrol will be
relatively more own-price elastic in the long run. Espey (1998)
estimated that the global short- and long-term own-price
elasticities of petrol were -0.23 and -0.43, respectively. If this
information is combined with the first Hicks-Marshall law –
own-price elasticity of mineral demand will be elastic when
own-price elasticity of demand for the final product is relatively
high – then the long run own-price elasticity of demand for crude
oil, which is used as an input in petrol, will be higher than the
short run own-price elasticity of demand for crude oil.
Even though many minerals are used in the manufacturing of
non-durable final products, the predominant use of minerals,
especially metals, is as inputs in the manufacturing of durable
final products, such as motor cars and new homes. The effect of
adjustment time on the demand for many durable final products
is different than for non-durable final products. Similar to
non-durable final products, durable final products are more
own-price elastic in the long run than in the short run as buyers
need time to adjust to new prices. However, an opposing effect
can lead final-product demand to be relatively more elastic in the
short run. This opposing effect is especially strong for large
changes in income. That is, the income elasticity of demand for
some durable final products tends to be greater in the short run
than in the long run. As a consequence, the income elasticity of
demand for minerals used in some durable final products is likely
to be higher in the short run than in the long run.
A second example involving motor vehicles illustrates that the
adjustment time for durable final products is somewhat different
to that for non-durable final products. Commonly, people
purchase new cars at intervals of several years. Now, suppose
that there is a fall in income. Some buyers will defer their plans
to replace their cars, keeping their present model a little longer.
Therefore, a decrease in income will cause purchases of new cars
to fall, all other things being equal. In the long run, buyers
eventually need to replace their cars and the effect of a decrease
in income may be minimal. As a result, a decrease in income will
cause demand for minerals used in motor cars to decrease more
sharply in the short run than in the long run. Similarly, if income
rises, people will replace their automobiles more frequently.
Therefore, an increase in income will tend to cause demand for
minerals used in cars to increase more sharply in the short run
than in the long run.
Consequently, the difference between short and long run
elasticities of demand for minerals used in durable products
depends on the interaction between the time needed to adjust to
the new final-product prices and the replacement frequency for
the final products.
We have just seen how time can affect the elasticities of
mineral demand. Now let us examine if the nature of income
elasticity of mineral demand over the long run can help make
long-range forecasts about the demand for minerals. It was
concluded above that economic booms tend to increase the
demand for minerals in the short run; however, prolonged
economic growth – that is, continual increases in Gross
Domestic Product – can correspond with a decrease in the
demand for minerals per person in the very long run.
Industry analysts commonly make mineral demand forecasts
by examining a mineral’s intensity-of-use. Intensity-of-use
reflects the demand for a mineral (usually measured in physical
units like tonnes) per unit of income discounted over time for
inflation (usually measured in billion dollars of gross domestic
product). In general, a country’s intensity-of-use of a mineral
follows an inverted U-shape when plotted against per capita gross
domestic product. Figure 5.12 shows a representative curve.
Tilton (2003) identifies two factors that cause this U-shape for
intensity-of-use curves They are changes in the product
composition of income and changes in the material composition
of products. The product composition of income mix change
occurs because of changes in consumer preferences as per capita
Australian Mineral Economics
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
tonnes/billion US $ of GDP
30
20
10
tonnes
0
0 1000 2000 3000 4000
Per capita GDP (US $)
FIG 5.12 - Intensity-of-use curve.
incomes rise. At low levels of development (low levels of per
capita GDP), when subsistence agriculture predominates, mineral
use tends to be minimal. Urbanisation and industrialisation propel
an increase in mineral demand to build basic infrastructure such as
roads, railways, bridges, factories, pipelines and power grids. As
development continues and per capita GDP increases further, the
need for basic infrastructure declines (the replacement frequency
for basic infrastructure is very low) and consumer demand shifts
increasingly towards services and non-durable final products,
which are less mineral-intensive. The transition from a
manufacturing-based economy to a service-based economy slows
and eventually reverses the trend of consumption of minerals as a
function of income.
The material composition of products refers to the amount of
minerals used to produce particular goods or services. Changes
in the material composition of products are driven by material
substitution and technological advancement. One major caveat of
the relationship shown in Figure 5.11 is that per capita GDP is
not a reasonable proxy for the underlying forces (technological
progress) that determine the trend in changes in the material
composition of products. This trend is more likely correlated
with time than with income. As a result, the inverted U-shape is
not stable, but rather typically shifts downward over time
(Guzman, Takashi and Tilton, 2005). Therefore, there is no
simple relationship between long run mineral demand and
income. The true relationship is complicated by a complex
interaction between price differences between materials,
technological change, material life-cycles, consumer tastes,
changes in lifestyle and other such factors (Campbell, 1985).
The Japanese economy provides a clear example of a change
in the product composition of income. In 1984, for every
inflation-adjusted billion yen of industrial production, Japan
consumed only 60 per cent of the raw materials that were
consumed for the same volume of industrial production in 1973
(Drucker, 1986). This trend corresponds to the switching away
from heavily material-intensive products to more high-
technology products.
The change in the material composition of products is clearly
visible with the trend towards more use of aluminium and
plastics and less steel in motor cars. In 1960, an average
automobile consisted of two per cent aluminium and one per cent
plastics, while in 1986 these percentages had increased to four
per cent for aluminium and seven per cent for plastics
(Kandelaars and van Dam, 1998). The substitution of aluminium
and plastics for steel in automobiles has caused a reduction in the
use of steel per automobile produced.
CONCLUSIONS
As identified earlier, most minerals are demanded as inputs for
final products such as motor vehicles, buildings, transportation
infrastructure, mobile telephones, jewellery and so forth. As a
result, there are characteristics of mineral demand that are
different from usual final-product demand. In particular, mineral
demand is strongly dependent on existing production technologies
and competing and complementary inputs of production.
47
CHAPTER 5: MINERAL DEMAND — THE THEORY IN PRACTICE
Furthermore, the demand for minerals depends on changes in
demand for final products, changes in technology and changes in
the mix of inputs.
Discussion in this chapter has also demonstrated that elasticity
of mineral demand is important from the standpoint of
understanding the magnitude of changes in mineral demand
caused by changes in price, income and the prices of related
products. The short run demand for most minerals is own-price
inelastic because manufacturers and consumers who use minerals
as inputs are constrained by their existing plants, equipment, and
vehicles. Also, the short run demand for most minerals is highly
income elastic. These high elasticities are a direct result of high
income elasticities of demand for final products in which
minerals are used as inputs. The combination of short-run
inelastic own-price elasticity of demand and elastic income
elasticity of demand results in many minerals having steeply
sloped demand curves that experience significant shifts over the
business cycle. Two important consequences of these features are
severe fluctuations in the market prices of minerals and profits
for mineral industry firms.
To complete the discussion of elasticity of mineral demand it
is important to examine the effects of time. Own-price elasticities
of mineral demand tend to be greater over the long term because
buyers have more time to adjust their behaviour. Also, the
income elasticity of demand for some minerals – those used as
inputs in durable final products – are likely to be more income
elastic in the short run than in the long run.
Finally, this chapter has demonstrated that the demand for
minerals is multifaceted. Understanding the demand side of the
mineral markets is essential for both analysts and policymakers
so that they can understand the economic implications of
changes in mineral markets.
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Fuerbringer, J, 2003. Gold rush may continue, but with tempered
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Gillett’s Jewellers, 2004. White gold versus platinum: white gold and
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Gruen, D and Shuetrim, G, 1994. Internationalisation and the
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productivity growth and natural resource and environmental
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official management of the gold price and the current state of the
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<http://www.lbma.org.uk/publications/alchemist/alch28_india.pdf>.
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Australian Mineral Economics
 CHAPTER 6

Mineral Supply — Exploration, Production, Processing

and Recycling
Philip Maxwell

Some Introductory Remarks

Resources and Reserves
Mineral Supply – Individual Products, Main Products, Co-Products and By-Products
Key Determinants of New Mineral Supply
Secondary Materials – The Economics of Recycling
Total Mineral Supply

SOME INTRODUCTORY REMARKS • The short run – as a time when mining companies ‘have
time to vary their output but not their capacity’.
Chapter 1 quoted from MacKenzie (1987), who noted the
importance of geological endowment in influencing the supply of • The long run – as a period when ‘new mines can be
minerals. Mineral deposits are: developed and processing facilities built’ and ‘firms can also
expand the capacity of existing operations’.
• initially unknown (they must be discovered and there is a
cost involved in doing this); • The very long run – as a period in which the ‘constraint
imposed by existing known... deposits no longer holds and
• fixed in size (they are a finite stock and with depletion are firms have the time to conduct exploration and find new
eventually exhaustible);
deposits. New technology induced by the exhaustion of
• variable in quality between and within deposits (this is known deposits and higher metal prices may also permit the
determined by grade, depth of deposit, mineralogy and other exploitation of new types of deposits’.
factors); and
A conceptual diagram showing the relations between these
• fixed in location (geological factors have often created these periods appears in Figure 6.1.
deposits in remote locations and they need to be moved to
intermediate and end-use markets).
Chapter 1 also highlighted that it is common practice to Immediate Short Long
classify mineral commodities into three categories – metals, run run run Very
non-metals and energy minerals. There are approximately 40 long run
metals, 40 non-metals and seven or eight energy minerals (see
Table 1.2). Also noted was that it is possible to recycle metals
and some non-metallic minerals from old-scrap and new-scrap
sources. This has the effect of postponing, and possibly even
preventing, their eventual depletion.
Despite consistently increasing consumption over the past
century, the issue of adequate mineral supply has been a
relatively infrequent source of concern. Where such discussions
about mineral supply have occurred, they typically take place
from both short-term and long-term perspectives.

Short-run and long-run supply Output Capacity Constraint of Quantity

constraint constraint current reserves (tonnes per period)
Using a standard textbook approach, Tilton (1985, pp 395-399)
defines the following periods:
• The immediate run – as an interval so short that mining FIG 6.1 - An interpretation of the relevance of different time
companies ‘do not have time to alter their rate of production’. periods to mineral supply.

Australian Mineral Economics 49

CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
Mineral supply has often been an issue in wartime, during
strikes, and in periods of high mineral prices such as that in the
1970s when the OPEC cartel constrained world oil supply.
Whenever oil and other mineral prices rise to high levels, as has
been the case in 2004 and 2005, commentators also become
concerned. Generally, however, they seldom debate this issue in
an active way because mineral prices have remained rather stable
or have moved lower in real terms1. This has happened in large
part because geologists have utilised advancing technology to
ensure that mineral reserves remain at manageable levels, mining
methods have become more efficient and there have been major
technical developments in mineral processing.
The issue of mineral supply in the very long run has attracted
even less attention over the past two centuries. Some notable
contributors have been Jevons in his 1865 Essay on the Coal
Question, and more recently commentators such as Meadows and
‘The Limits to Growth’ school in the early 1970s. Authors such
as Tilton (2003) and Krautkraemer (1998) provide useful surveys
of the associated discussion. Perhaps the most notable theoretical
contribution has been by Hotelling (1931) in his paper, The
Economics of Exhaustible Resources.
Given the state of current technology, there is a general
consensus that the world has enough minerals for the next 50
years. After that, the situation seems less clear. In his recent
analysis of this issue, Tilton (2003) argues that four groups of
factors will influence the situation: geology, the demand for
primary mineral commodities, and changes in technology and
input costs.
While acknowledging this broad debate, the main focus of this
chapter is more concerned with the short run and the long run,
seeking to highlight the distinct features of mineral supply in
these periods and, in conjunction with the preceding discourse on
mineral demand by Peter Howie, building the foundations for the
discussion of mineral market outcomes described by Phillip
Crowson in the next chapter.
The mineral supply process
A simple view of new mineral supply, following MacKenzie
(1987), is to see it as a process involving exploration, project
development, mining, processing and transportation to the
market. The flow of minerals supplied in a given period
generally involves the depletion of a finite mineral stock. One
can view this in terms of the following equation that shows the
relationship between current mineral reserves, new mineral
supply, recycled materials and additions to stocks from new
discoveries, technological change or changes in prices.
Mineral = Mineral - New mineral + Amount of mineral
reserves reserves consumption recycled last
this period last period last period period
+ New mineral
reserves
discovered or
available last
period
While the world’s minerals are fixed in supply and technically
non-renewable, it is possible to recycle many of them.
Significant percentages of current supplies of metals such as
aluminium, copper, nickel, lead and zinc come from the
recycling of old and new scrap. If the demand for a mineral falls
away, it is even conceivable that recycled materials could meet
all new mineral demand and it would not be necessary to produce
newly mined material.
1. See, for example, Peter Howie’s estimates of Real Prices for Selected
Mineral Commodities, 1870-1997 in Tilton (2003).
50
The world’s mineral stock is also affected by new discoveries,
by technological advancements in mineral processing that make
previously uneconomic deposits profitable, and by variations in
prices, which may add to or reduce the size of current mineral
reserves.
Supply curves
In addition to geological endowment, a variety of other factors
also influence mineral supply. They include whether a mineral is
an individual product or joint product, the price of the mineral,
input costs, transport costs, government policy, institutional
efficiency, technological change, the impact of strikes and other
disruptions and market structure.
The familiar supply curve framework is utilised to explain the
relevance and importance of the above key determining factors.
Students in Economics Principles classes learn about supply
functions and curves in the early weeks of their course. The
typical initial presentation of supply is as an upward sloping
curve on a diagram such as Figure 6.2, where price per unit is
plotted on the vertical axis and quantity produced per period is
on the horizontal axis. As prices rise, producers will be
encouraged to produce more because it is profitable to do so. As
price falls, they will produce less.
In this presentation, price is a variable and all of the other
factors that affect the quantity supplied are held constant. If their
values change, the supply curve will shift to the left or right as in
Figure 6.2b.
RESOURCES AND RESERVES
At any given time, the level of estimated resources and reserves
provides a benchmark for the status of mineral supply.
Discussion will now begin from this base, before considering the
nature of mineral supply using the above supply curve model.
Price
S
P2
P1
S
Q1 Q2 Quantity per
A time period
S1
Price
S
S2
P1
S1 S S2
Q1 Q Q2 Quantity per
B time period
FIG 6.2 - A typical supply curve. (A) Price changes and quantity
changes, and (B) changes in other factors and quantity changes.
Australian Mineral Economics
 CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
Mining companies publish information about the mineral
reserves and resources associated with their projects, while
national agencies such as the United States Geological Survey, the
British Geological Survey and Geoscience Australia2 generate
parallel estimates for individual nations and the world as a whole.
Reasonably standard definitions of resources and reserves
(Tilton, 2003, p 19) are as follows:
Reserves are those ‘quantities of a mineral commodity in
subsurface deposits, that are known and profitable to exploit,
given existing technology and prices,’ while:
Resources include reserves, together with deposits that are:
• economic but not yet discovered; or
• expected to become economic as a result of new technology
or other developments within the foreseeable future.
The major mineral producing nations use their own generally
similar definitions of resources and reserves. While the most
common classification system is probably the McKelvey ‘Box’
of the United States Geological Survey, the JORC Code is the
standard in use in Australia. This is the product of a collaborative
effort within the Joint Ore Reserves Committee of The
Australasian Institute of Mining and Metallurgy, the Australian
Institute of Geoscientists and the Minerals Council of Australia.
Details of the code appear in JORC (2004).
2. A relevant recent reference is to Geoscience Australia (2004).
Exploration results
Mineral Resources Ore Reserves
Inferred
Increasing level
of geological
knowledge and Indicated
confidence
Measured
Consideration of mining, metallurgical, economics, marketing,
legal, environmental, social and government factors
(the “modifying factors ”)
FIG 6.3 - The general relationship between exploration results,
mineral results and ore reserves (JORC Code, 2004).
Price Price
S0 S1
P1
D0
D1
q1
Quantity per
unit time
(a)
FIG 6.4 - One view of current new mineral supply, mineral reserves and potential mineral supply.
Australian Mineral Economics
The information in Figure 6.3 outlines ‘the framework for
classifying tonnage and grade estimates so as to reflect different
levels of geological confidence and different degrees of technical
and economic evaluation’. Because the geological and modifying
factors change on an almost continuous basis, statements of
reserves and resources regularly change.
It is interesting to consider further the relationship of a
framework for resources and reserves such as the JORC Code, to
a supply curve model for newly mined minerals. The diagrams in
Figure 6.4 illustrate one attempt to do this. They are adapted
from the work of Chavez-Martinez (1983), as reported in Harris
(1985). Looking at Figure 6.4a, it can be seen that in a given
period, the market will clear at a price of P1, where q1 of the
mineral, say copper or iron ore, is mined and produced. This
corresponds in Figure 6.4b to the marked amounts of cumulative
production and current reserves.
At current levels of technology and factor (input) prices,
increments to new supply are possible with new capital
investment but only at higher prices. These are shown in
Figure 6.4c. Technological advancement in exploration, mining
methods, mineral processing and recycling, as well as changes to
mineral demand, will affect the level of reserves and potential
future supply. In a JORC view of the world, only proved mineral
reserves appear in the ‘Reserves’ rectangle.
MINERAL SUPPLY – INDIVIDUAL PRODUCTS,
MAIN PRODUCTS, CO-PRODUCTS AND
BY-PRODUCTS
Their geological occurrence is such that sometimes it is
profitable only to recover one mineral commodity (an individual
product) from the material mined or drilled. In Australia’s major
mining regions, companies produce bauxite, coal, gold, iron ore
and diamonds as individual products. Some of the less
fashionable minerals such as many construction materials,
gypsum, limestone, salt and talc also are extracted in this way.
On other occasions, there is joint production. Here miners
Probable extract mineral commodities as main products, co-products or
by-products. It is important to appreciate the meanings of each
Proved
of these terms.
Following Tilton (1985, p 393):
a main product is so important to the economic
viability of a mine that its price alone determines
a mine’s output; and
a by-product …. is so unimportant, its price has
no influence on mine output; and
when prices of two or more (minerals) affect
output, the (minerals) are co-products.
Price
S”
S’
P3
P2
Cumulative
production
Reserves
Potential
supply
Quantity of stock Changes in supply
(b) (c)
51
CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
TABLE 6.1
Estimated value of production of Australian nickel industry 2003.
Source: Western Australian Government (2004).
Mineral Value ($ million) Percentage
Cobalt 140 5.1
Platinum 4 0.1
Palladium 4 0.1
Nickel 2607 94.7
Total 2755 100.0
A good way to distinguish between these terms is to consider
the mining of nickel in Australia during 2003. All of Australia’s
nickel mining currently occurs in Western Australia. As can be
seen in Table 6.1, the Western Australian Department of Industry
and Resources (Western Australian Government, 2004) reported
that the value of nickel industry production in 2003 stood at
$2755 million. But as well as nickel, mining companies also
produced platinum, palladium and cobalt at their operations.
Platinum and palladium were clearly by-products. Cobalt also
seems to be very much a by-product because it contributed only
about five per cent of the total value of production, even though
this amounted to $140 million.
Most nickel in Western Australia comes from nickel sulfide
deposits. Yet in the mid-1990s there was considerable excitement
about the potential of producing nickel and cobalt as co-products
from dry laterite deposits at places such as Murrin Murrin,
Cawse and Bulong. Mining began at each of these deposits but
Murrin Murrin was the only mine producing in this way in 2003.
It produced just over 32 000 tonnes of nickel metal in 2003 (with
a value of $437 million) and 2160 tonnes of cobalt metal (valued
at $58.5 million). In this mine, the value of cobalt production
was 11.8 per cent of the value of total mineral production. While
it is an arbitrary judgment, most analysts would agree that cobalt
was a by-product at Murrin Murrin in 2003. If the price of nickel
fell by 50 per cent and the price of cobalt doubled, cobalt would
then become very much a co-product.
Examples which could typically be thought of are co-products
from base metal mines around places such as Mount Isa and
Broken Hill. Another good example of an Australian mine where
co-products are most likely to be produced is Olympic Dam.
According to the WMC Resources website (WMC Resources,
2005), this mine produced 89 000 ounces of gold, 862 000
ounces of silver, 225 000 tonnes of copper and 4404 tonnes of
uranium in 2004.
KEY DETERMINANTS OF NEW MINERAL SUPPLY
Individual and main products
A standard way to consider the supply function of an individual
mineral commodity such as coal, bauxite, iron ore, gold, and
nickel and copper when they occur as main products, is in the
following terms:
Mineral = f (own price, input costs, technological change, disruptive
supply events, government activities, market structure)
This specification follows Tilton (1985) and includes most of
the important influencing variables. It implicitly assumes that
there are sufficient reserves of the mineral available for
exploitation.
It is useful to briefly reflect on the influence of these factors.
According to the standard theory of the firm, a company will
maximise its profits by producing at a point where the costs of
the last (marginal) unit of output just offsets its price. When the
52
price of a mineral rises, a mining company will tend to increase
its supply. When it falls, it will reduce supply. The industry will
respond in the same way. Where the global price of a commodity
is expressed in terms of another currency, eg United States
dollars, exchange rate variations have a similar effect to
changes in price.
In the short run, however, capacity constraints in existing mines
will inhibit the ability of supply to increase as prices rise. A
company can employ more workers and expand its operations
within current mining tenements but its ability to increase supply
will be limited. With the need for regulatory approvals, and major
capital investment for mines, mills and supporting infrastructure
such capacity constraints can apply for several years.
Input costs, particularly wages and energy costs, are
important factors affecting mineral commodity supply. When
they rise, it becomes more difficult for producers to make profits.
While wage levels of mining workers are high, their relatively
small numbers probably make the effects of rising wages less
important than changes in energy prices. These are particularly
important, for example, in transforming bauxite into aluminium.
Producing aluminium requires so much electric power that it has
sometimes jokingly been described as ‘frozen electricity’.
The positive impacts of technological change on mineral
supply through more sophisticated mineral exploration, better
mining methods and innovations in mineral processing have been
substantial. They have more than offset the depletion of
higher-grade deposits and the subsequent movement to lower
grades. With positive impacts of open cut mining and the
implementation of carbon in pulp leaching and associated
advances in mineral processing, it has become possible to
produce gold from deposits containing much less than one gram
per tonne. Profitable extraction was previously possible only at
much higher grades.
A variety of disruptive events such as strikes, accidents in
major mines, major equipment failure in mineral processing
plants, natural disasters such as bush fires, floods and cyclones
(known elsewhere as hurricanes or typhoons), civil disturbances
or even terrorist attacks can disrupt mineral supply.
During 2004, for example, when the price of oil rose from
around US$ 30 per barrel to US$ 55 per barrel, the disruptive
impacts of events in Iraq were one source of concern about oil
supply. Threatened supply disruption associated with strikes by
oil workers in Venezuela and Nigeria during the year added to
this impact.
Canada has been the major nickel producing nation for the past
century. Strikes by workers in its key nickel mining region
around Sudbury have disrupted world supply on several
occasions. Because such disruption tends to drive up prices,
Australian producers derived considerable benefit.
Northern Australia has a cyclone season every year from about
January to April. Even though they are in remote and often quite
arid areas, large operating mines sometimes are badly affected by
the aftermath of these major storms. This occurs unexpectedly in
areas such as North West Queensland, the Northern Territory, the
Pilbara, the Kimberley, and even as far south as the Goldfields
region of Western Australia.
A graphic example of the impact of disruptive events on the
fortunes of one mining company in the mid-1990s applied to the
large mineral sands producer, Consolidated Rutile. The firm was
forced to close its operations in Sierra Leone, when several key
operational personnel were kidnapped. About a year later, a
major bush fire disrupted their key operations on Stradbroke
Island in Queensland.
The activities of governments also have a major impact on
mineral supply. The mineral policy of a state or nation has a
central effect on its ability to supply minerals, assuming that it
has a significant mineral endowment. Hence the clear and stable
regulatory framework in Australia has served the nation well as
far as mineral sector competitiveness is concerned. It has been
Australian Mineral Economics
 CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING

assisted by strong government support of organisations, such as TABLE 6.3

Geological Surveys that maintain significant databases and Market structure and degree of competitiveness in selected
Departments of Mines that administer the operation of the mineral industry sectors.
minerals and energy sector. In Australia, the states also collect
royalties from companies with operating mines. Number of buyers
Significant policy changes may, of course, affect this situation. Number of sellers Small Large
For example, the introduction of more stringent environmental Small Iron ore, nickel, tin Oil, many less
regulations can adversely affect mineral supply. If such significant minerals
regulations are less onerous in mineral-rich foreign political (eg lithium, platinum)
jurisdictions, the principals of resources companies will be more
Large Aluminium Gold, copper, zinc
tempted to invest in these regions. The Mabo judgment in the
Australian High Court in 1992, and the subsequent passage of
Native Title legislation in the Australian Parliament in 1993, is Economists often analyse the selling side of markets by
another recent example of how new policy may potentially computing concentration ratios and indexes. The Raw Materials
influence mineral supply. Group, based in Stockholm, has specialised in this area. Some of
The end of the colonial era in the 1960s and 1970s, was their data show how, for example, the percentage shares of iron
associated with the emergence of state-owned mining industries ore producing companies have increased over the past 30 years –
in many of the new nations. Political leaders wished to channel see Table 6.4. Yet it is also notable that rising concentration
the economic rent from the resources sector to build other parts levels have been accompanied by increasing globalisation of the
of their emerging societies. Where foreign companies operated in iron ore industry. To some extent this has mitigated against the
these nations, they often faced requirements to purchase supplies rise in market power that the concentration ratio growth suggests.
from domestic producers, or to process ores or concentrates
within the national boundaries, or both. Another common
practice was, and continues to be, the requirement to engage TABLE 6.4
citizens of the host nation in professional and managerial roles The consolidation of iron ore production 1975 to 2003.
within resource companies. Working visa limitations for Source: Ericsson (2002, 2004); Anonymous (2004).
expatriates seek to facilitate the impact of this. In several cases, a
lack of investment and human capital led to the decline of the Year Percentage share of production
mineral industry in these nations. Since 1985, more than a Western world† Largest Largest three Largest ten
hundred nations have made major changes to mineral policy to company companies companies
enhance their appeal to new mineral investment.
1975 8.0 17.2 40.8
Other favourable government policies that sometimes apply to
encourage new mineral production include commitments to build 1990 15.4 31.4 58.3
infrastructure such as roads, ports and communications systems. 1995 15.5 34.2 60.5
Another policy is to offer low interest loans. Where mines or 2001 23.2 46.2 70.2
mineral processing plants are struggling, government may also
2002 23.2 47.6 72.1
provide operating subsidies.
Market structure also has an important influence on the World
supply of individual and main products. This is a particular focus 2002 14.8 30.3 36.3
of attention in the next chapter. When there are few mineral 2003 18.2 45.9 54.2
producers, they exert greater influence on supply and price.
While the influence of state-owned mining corporations has † Difficulties in obtaining data from nations in the former Communist
declined since the early 1980s, there has been a significant trend bloc meant that world production data estimates have not been
towards greater concentration in many of the major minerals reliable until quite recently. Western world data was reported instead
sectors since the middle of the 1990s. The number of buyers is before this time. This practice reflects one of the many difficulties
also an important influence on market structure and the that professionals have faced in obtaining accurate mineral
competitive state of particular mineral markets. Few buyers tend production (and consumption) data.
also to exert large amounts of market power. Interestingly the
combination of few buyers and sellers can generate market They suggest growing market power among large producing
outcomes similar to those where there are many buyers and companies, as their percentage shares of production have risen.
sellers. The simple matrix in Table 6.2 provides a rudimentary These large producers face a number of large buyers from
view of how these influences tend to apply. different nations such as Japan and now China to negotiate iron
It is instructive to reflect on how different mineral commodities ore contracts on an annual basis. Phillip Crowson’s discussion in
have traditionally fitted into this matrix. The entries in Table 6.3 the next chapter extends the discussion of the importance of
provide some indication in this regard. It has been typical to market structure for mineral supply across the resources sector.
consider the gold and copper sectors as relatively competitive, Where producers exert large amounts of market power, they
while there are few buyers (steel mills) and few sellers (major iron tend to set prices – so called producer prices in a producer
ore companies) of iron ore. market. Such prices will typically guarantee producers a healthy
profit. They may be based on some multiple of average total
TABLE 6.2 costs of production, or alternatively on some other criterion that
Market structure and competition – a rudimentary view. will return a greater than normal profit to the producer. At the
other end of the scale lies a competitive outcome where firms are
Number of buyers price takers and adjust their output to generate optimum profit.
Number of sellers Small Large They will produce when they can make a surplus, but will cease
Small Market power on each Strong market power on operations if they cannot cover their average variable costs.
side tends to offset one selling side An alternative view regarding this standard textbook result is
another and outcomes that this is not necessarily true in the mining industry because
may be competitive of high closure costs particularly because of environmental
Large Strong market power on Competitive considerations and other factors. This has been one of the
buying side arguments about why the price of mineral commodities, such as

Australian Mineral Economics 53

CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING

zinc and lead, have remained so depressed over long periods, supply curve is horizontal, as is the case for producer pricing
producing an inadequate rate of return to investors. well before capacity constraints are approached, own price
As prices rise, higher cost producers will begin producing, elasticity is effectively infinite. With the passage of time, the
though production constraints apply because of: elasticity of supply tends to increase. Hence the own price
elasticity of supply will be greater in the long run than it is in the
• current output and inventory levels in the very short run; and immediate run or short run.
• mine capacity in the short run, and the size of reserves in the
long run. By-products
In the very long run, new discoveries and technologies may Because mineral by-products are so unimportant to a mine and
drive down production cost, and therefore the prices that their price has no influence on their output, their supply
producers are willing to accept. A standard view of the position functions differ from those of individual or main products.
of competitive producers (following Tilton, 1985) appears in Crowson (1998, p 81) has argued:
Figure 6.5. By contrast, firms in producer markets set prices for
That many metals and minerals are produced
given periods of time, often annually. If this is the case (again
partly or solely as by-products introduces great
following Tilton, 1985) a set of horizontal cost-based curves,
rigidities to their supply. It means that their
such as those that appear in Figure 6.6, could be expected. output will not always respond to changes in
Price Immediate Short Long
their own prices, but is often more influenced by
run run run the prices of the main products with which they
are associated.
This seems to be the case in much of the Australian industry
Very where specific mines produce more than one mineral commodity.
long run In Western Australia, for example, in 2003, payable mineral
by-products were worth an estimated A$ 173.1 million – see
Table 6.5. While this value was significant, it was less than one
per cent of the value of the state’s mineral and energy production
in that year. At mines in other parts of the country selenium and
tellurium is produced with copper, indium and germanium with
zinc, bismuth with lead, gallium with bauxite, zircon with
ilmenite, molybdenum with copper and silver with base metals.
Output Capacity Constraint of Quantity
constraint constraint current reserves (tonnes per period)
TABLE 6.5
FIG 6.5 - Mineral supply curves during different time periods in Estimated value of mineral by-products in Western Australia, 2003.
competitive markets. Source: Western Australian Government (2004).

Main or By-product Place† Value

co-products (A$ million)
Gold Copper Goldfields 8.3
Long run Nickel Cobalt Goldfields 60.2
compounds
Very long run Nickel Cobalt metal Goldfields 79.3
Short run
Nickel Palladium Coolgardie 4.0
Immediate
run
Nickel Platinum Coolgardie 4.3
Various Silver Statewide 15.4
Copper and zinc Lead Yalgoo 1.6
Total value of by-products 173.1
Output Capacity Constraint of Quantity
constraint constraint current reserves (tonnes per period)
† District, region or local government area.

FIG 6.6 - Mineral supply curves during different time periods in

producer markets.
These representations imply certain assumptions about the
way in which the quantity that producers supply will respond to
price changes. The usual way to assess such responsiveness is in
terms of the elasticity of supply. This is a parallel concept to the
elasticity of demand discussed in the last chapter.
Economists typically focus on own price elasticity of supply.
The simple formula for this for a particular mineral in a given
period (say a year) is:
per cent change in quantity supplied
Es =
per cent change in own price
Supply is elastic when Es is greater than one, and is inelastic
when it is less than one. As production approaches capacity
constraints, and the mineral supply curve becomes vertical, own
price elasticity of supply approaches zero. Where the mineral
Consider, for example, the relevance of Crowson’s statement
for cobalt produced in Western Australia. Mines in the state were
responsible for about 11 per cent of newly mined cobalt
production in 2003 – just over 5100 tonnes of the world total of
46 900 tonnes. All of this was produced in association with
nickel, whose production value exceeded $2.6 billion in 2003.
In the three dry-laterite nickel operations (Murrin Murrin,
Bulong and Cawse) that produced nickel and cobalt metal as end
products, nickel accounted for about 85 per cent of the value of
total production.
Because of the relative unimportance of by-products, only the
costs that are specific to their production affect their supply.
Companies allocate the joint costs of producing main products
and by-products only to the main products. This means that the
average cost of by-product production is typically very low.
It may even approach zero, if in producing the main product, the
company naturally separates out the by-product, which requires
no further processing.

54 Australian Mineral Economics

 CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
Yet the price of a by-product does influence its production in
one notable way. If the price of the by-product falls below the
production costs specific to its production per se, the producer
will have an incentive to discard the by-product as waste rather
than process it to a saleable product.
Technological change can, of course, change the status of a
by-product to that of a co-product or even reverse the main
product/by-product relationship. Price movements can also have
this effect. Consider again the situation of the Murrin Murrin
nickel mine. In promoting this project in the mid-1990s, the
Directors of Anaconda Nickel argued that nickel and cobalt
would be co-products. At the time the price of cobalt stood at
over A$ 60 per kilogram, while nickel was selling for A$ 10 per
kilogram.
Assuming 2003 production rates (32 125 tonnes of nickel
metal and 2300 tonnes of cobalt metal), the mine would have
generated annual revenue of A$ 460 million in that year. About
70 per cent would have come from nickel and 30 per cent from
cobalt. In such a scenario, most commentators would accept that
these metals were co-products. By 2003, however, the average
price of cobalt had declined to A$ 27.50 per kilogram, while
nickel stood at A$ 13.60 per kilogram. Of the annual mine
revenue, over 87 per cent came from nickel and less than
13 per cent was from cobalt. Cobalt was now a by-product.
Against this background it seems reasonable to argue that the
mineral by-product supply function would take the following form:
Mineral = f (by product price, main product price, specific
by-product by-product input costs, technological change, disruptive
supply events, government activities, market structure)
If one draws by-product supply curves in the usual way (see
Figure 6.7) with price on the vertical axis and quantity on the
horizontal axis, immediate run and short run curves are initially
elastic but then quite quickly inelastic as they come up against
output and capacity constraints. There is greater initial own price
elasticity of supply in the long run and very long run, though
again this changes when the by-product constraint is reached.
Price Long run
Immediate Short
run run and
very long run
By-product
constraint
C1
O comes from pre-consumer sources while ‘old scrap’ originates
Output Capacity Quantity
constraint constraint (tonnes per period)
FIG 6.7 - Supply curves for mineral by-products.
3. During the Cold War, another source of mineral supply for nations
such as the United States was strategic stockpiles. These have
become less important in recent times.
4. As noted earlier, the United States economy’s GDP has recently
stood at around 30 per cent of world GDP, implying that the US is
responsible for a significant amount of mineral consumption. Given
the nature of the intensity of use of mineral commodities during the
stages of economic development, it seems reasonable to argue,
however, that consumers in the United States are unlikely to be
consuming equivalent percentages of mineral commodities.
Australian Mineral Economics
Co-products
As outlined above, when the prices of two or more minerals
produced by a mine affect its output, they will be co-products.
The price of the co-product must cover its specific production
costs and an appropriate share of its joint production costs with
other co-products.
The range of factors that affect the supply of a co-product from
a mine lies between those that influence main products and
by-products.
It therefore seems reasonable to argue that the mineral
co-product supply function would take the following form:
Mineral = f (own price, co-product prices, specific co-product
co-product input costs, technological change, disruptive events,
supply government activities, market structure)
Co-product supply curves will have a similar look to the main
product supply curves depicted in Figures 6.5 and 6.6, though the
sharing of joint production costs may mean that they are a
‘pushed-down’ version of these curves until the various output,
capacity and known deposit constraints are reached in the
immediate run, short run and long run respectively.
SECONDARY MATERIALS – THE ECONOMICS OF
RECYCLING
Newly mined minerals, which deplete finite mineral resources,
traditionally have made up the majority of mineral production.
But in recent times, recycling of minerals, particularly metals,
has also become an important alternative source of supply3 . This
is particularly the case in developed nations where public policy
makers are encouraging recycling more and more.
While authoritative data about mineral recycling are not
available on a world basis for all minerals, the US Geological
Survey provides annual estimates of its importance for most key
minerals in the United States (see United States Geological
Survey, 2003). Although these rates may not carry entirely across
to Australia, they do provide some indicative ideas about the
importance of the use of secondary materials in mineral supply,
given that the United States is a major mineral consumer4. The
estimates for ten key minerals appear in Figure 6.8. Recycling
rates for materials such as lead (mainly for batteries, at 72 per
cent), iron and steel (58 per cent), nickel and magnesium (both
45 per cent), titanium (40 per cent) and aluminium (36 per cent)
are all significant. Recycling of metals such as gold and silver is
also important.
While many of the above percentages are high, it is important
also to realise that they are derived from two broad categories –
so-called new scrap and old scrap. The authors of United States
Geological Survey (2003, p 62.1) advise that metal ‘new scrap’
from post-consumer sources. Hence:
…when metals are converted into shapes – bars,
plates, rods, sheets, etc new scrap is generated in
the form of turnings, stampings, cuttings and
off-specification materials.
Because much ‘new scrap’ supply is derived from new mine
production, it hardly seems to be secondary supply. ‘Old scrap’,
by contrast, comes from products that have reached the end of
their useful lives – from old cars, computers, household
appliances, car batteries and many other products. The
availability of ‘old scrap’, as a percentage of total mineral use,
will depend on the lives of products in which it has been an
input, the cost of recycling and the rate of recovery of the
mineral in question.
55
CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING

100%
90%
80%
72%
70%
58%
60%
50% 45% 45%
40%
40% 36%
29% 30%
30% 26%
20%
20%
10%
0%

um
n
m

nc
m

l
m
pe

ee

ke

Ti
a
iu

iu

iu

Zi
Le

ni
st

ic
op
in

om

ta
N
ne
&
m

Ti
hr
lu

ag
n
Iro
C
A

M
FIG 6.8 - Estimated US recycling rates for selected metals – 2002.

100%

90%
80%

70%
60%

50%
40%

30%
20%

10%
0%
Aluminium Copper Lead Magnesium Tin Zinc
New scrap 21.7% 24.4% 2.3% 29.1% 7.0% 22.3%
Old scrap 14.5% 6.0% 69.5% 16.3% 12.5% 3.3%

FIG 6.9 - Estimated rates of recycling new and old scrap for six selected minerals in the United States of America – 2002.

Suppose that the supply (and consumption) of a mineral grows
at an annual rate of three per cent per annum over a quarter of a
century. After that period, the products in which it has been an
input becomes obsolete and can be recycled. Suppose further that
it is profitable to recycle half of the metal in these worn out
goods. It is a straightforward exercise to calculate that about
23 per cent of mineral supply at the end of this period can come
from ‘old scrap’ material. It is interesting to note in Figure 6.9
that, for the six metals whose secondary supply is separated into
new scrap and old scrap, only lead stands out as having a highly
significant rate of old scrap recycling.
The supply of new scrap minerals
This supply will be relatively cheap to recycle and reasonably
elastic until it comes up against a capacity constraint. As Tilton
(1985, p 402) notes with respect to metals, the factors affecting
this constraint are:
• ‘current overall metal consumption;
• the distribution of this consumption by end uses; and
• the percentage of consumption resulting in new scrap for each
end use’.
Some supply of new scrap takes place in reasonably
competitive markets, though vertical integration strategies for
other minerals may ensure that producer pricing continues to
prevail in this area.
A reproduction of Tilton’s view of the supply of new scrap in
competitive markets appears in Figure 6.10.
What stands out in this representation is the similarity of the
immediate run, the short run and the long run and very long run.
One would assume that the recycling cost would be pushed down
over time by small amounts. Although not shown in the diagram
it is also possible to assume that the capacity constraint could be
pushed out a bit by technological advance in the long run/very
long run. However, the message of this diagram is elastic low
cost supply that is subject to a capacity constraint.
Old scrap mineral supply
In the example at the beginning of this section, we referred to a
flow of any mineral to secondary supply resulting from products
coming to the end of their service lives. Usually there is also a
stock of old scrap material containing different minerals that has
built up over time and has not yet been recycled. This is typically
because the price of newly mined minerals has been less than the
cost of recycling from this old scrap.

56 Australian Mineral Economics

 CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
Price Availability
constraint
Short
run
Immediate
run
Long run and
very long run
Quantity
FIG 6.10 - The supply of new scrap minerals in competitive
markets.
Although subject to less of a supply constraint because the
stock of old scrap may be large, the cost of processing material is
considerable for most minerals. This is because it needs to be
collected and then processed. Where collection and processing
are cheap, and consumption of a mineral has been growing
slowly, the supply of a mineral from old scrap can be significant.
This is the case for the recycling of lead from lead acid batteries,
the main current use of lead. With the removal of lead from paint
and as a petrol additive contributing to static recent levels of
consumption, it is easy to understand why the percentage of lead
recycled from old scrap is so high.
It is possible to construct indicative short run and long run
supply curves for secondary materials from both the flow and
stock of old scrap, and then add them to derive an old scrap supply
curve – see Tilton (1985, pp 403-405). Because the process is
somewhat complex, it will not be developed here. Such curves will
be upward sloping in the usual way and relatively inelastic.
TOTAL MINERAL SUPPLY
The total mineral supply that becomes available in any period is
the sum of new mineral supply and secondary supply. The
newly mined supply of a mineral may appears as:
• an individual product,
• a main product,
• a by-product, or
• a co-product.
Secondary supply can emerge from the flow of old scrap or
the current stock of old scrap material available. The concept of
new scrap is often added to this, though it is arguable that such
‘new scrap’ may alternatively be considered to be part of newly
mined supply.
A typical way of visually representing a total mineral supply
function is to horizontally sum supply curves for each of the
components of new supply and secondary supply for various
periods:
• the immediate run,
• the short run,
• the long run, and
• the very long run.
Conducting this exercise for a metal such as gold or silver, that
occurs in all of these forms, will be quite a complicated though
necessary exercise. As one moves from the immediate run to the
longer run views, all of the factors that affect each of the
Australian Mineral Economics
different forms of production are likely to change. By contrast,
for a mineral such as coal that occurs only as an individual
product and is not recyclable, this exercise will be much more
straightforward.
To illustrate the construction of a total mineral supply curve
without going into excessive complexity, suppose that we have a
mineral that occurs as a main product and a by-product and
that can be recycled from old scrap. A metal such as cobalt
might provide a good example of such a mineral. Even though
cobalt is not traded on the London Metal Exchange or the New
York Mercantile Exchange, there are enough producers and users
to suggest that a reasonably competitive market exists for this
metal. Its long run supply in a competitive market place is
considered in Figure 6.11. The components are shown separately
in Figure 6.11a and summed horizontally in Figure 6.11b. In this
latter diagram a simple version of a long-run mineral supply
curve is derived.
Old By-product
Price scrap Main
product
P0
P3
Capacity
constraints
P2
P1
A Quantity
Total
Price Supply
curve
P0
P3
P2
P1
Quantity
B
FIG 6.11 - A total long run supply curve for a mineral produced
as a by-product, from old scrap and as a main product. (A) Old
scrap, by-product and main product supply curves, and (B) total
supply curve.
It is interesting to compare the shape of a mineral supply curve
such as that in Figure 6.11b, or perhaps more suitably of a
corresponding short run mineral supply curve, with that of the
cost curves that mining executives can obtain on a regular basis
for widely traded individual and main product minerals from a
number of prominent industry consultants. These are based on
cash costs.
In discussing the behaviour of firms economists commonly
distinguish between their fixed costs and variable costs. The latter
vary with output while the former are the same regardless of the
level of output. Yet this distinction is often blurred in the mining
process as Crowson (1998) notes. Operators of many mines seek
to spread their costs over as great an output as possible. Also
annual purchase contracts for fuel and supplies blur the distinction
between mining and its associated first-stage processing.
57
CHAPTER 6: MINERAL SUPPLY — EXPLORATION, PRODUCTION, PROCESSING AND RECYCLING
Average Cost
per tonne
$9,000
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
M1 M2 Mine 3 Mine 4
By-
$1,000
product
$0
0 100 200 300 400
FIG 6.12 - A hypothetical total average cost (supply) curve for newly mined nickel in a recent time period.
It has therefore become common practice to distinguish
between cash costs and other costs within the mining industry.
They refer to all fixed and variable costs sustained in cash rather
than as ledger entries when operations are taking place. They
include all site costs of mining such as stripping, processing,
concentrating, but also incorporate sales and marketing.
Industry analysts produce average short run cash cost and
total cost data for different mines for various mineral sectors.
They have not typically also included data on recycling. As an
example, an indicative short run operating cost curve for newly
mined nickel might look like the curve in Figure 6.12. Such
curves provide an approximation for a short run supply curve for
newly mined production5. They provide useful competitiveness
benchmarks for new and existing producers. Yet because these
data are usually commercially sensitive and collected by only a
few organisations, they are not widely available in the public
domain. Indeed they tend to be prohibitively expensive to
observers who do not depend on them to generate significant
income streams.
In summary, the discussion in this chapter has sought to
introduce the discussion of mineral supply in a fashion that
integrates it with the preceding review of the elements of mineral
demand. When combined, it is hoped that they will be found to
provide a useful framework for Phillip Crowson’s discussion of
mineral markets in the next chapter.
5. It should be acknowledged that the sum of producer marginal cost
curves, rather than average cost curves, are the components of an
industry supply curve for producers in any competitive industry.
REFERENCES
Anonymous, 2004. Note: Corporate control in iron ore mining in 2002,
Minerals and Energy, 19(2):36-38.
Chavez-Martinez, M L, 1983. A potential supply system for uranium
based on a crustal abundance model, PhD dissertation, University of
Arizona, Tucson.
Crowson, P, 1998. Inside Mining: The Economics of the Supply and
Demand of Minerals and Metals (Mining Journal Books: London).
58
Other mines
500 600 700 800 900 1000
Quantity (kt)
Ericsson, M, 2002. Mining M&A reaches record levels in 2001, Minerals
and Energy, 17(1):19-26.
Ericsson, M, 2004. Iron ore – The world market, The AusIMM Bulletin,
5:70-75.
Geoscience Australia, 2004. Australia’s Identified Mineral Resources
2004 (Australian Government: Canberra). [online]. Available from:
<http://www.ga.gov.au/image_cache/GA5476.pdf>. Date accessed:
8 May 2006.
Harris, D P, 1985. Mineral resource information, supply and policy
analysis, in Economics of the Mineral Industries, fourth edition (ed:
W A Vogely), pp 181-224 (The American Institute of Mining,
Metallurgical, and Petroleum Engineers: New York).
Hotelling, H, 1931. The economics of exhaustible resources, Journal of
Political Economy, 39(2):139-175.
Joint Ore Reserves Committee (JORC), 2004. Australasian Code for
Reporting of Mineral Resources and Ore Reserves (The JORC Code),
The Joint Ore Reserves Committee of The Australasian Institute of
Mining and Metallurgy, Australian Institute of Geoscientists and
Minerals Council of Australia. [Online]. Available from: <http://www.
ausimm.com/codes/jorc0105.pdf>. Date accessed: 8 May 2006.
Krautkraemer, J A, 1998. Non-renewable resource scarcity, Journal of
Economic Literature, 36:2065-2107.
MacKenzie, B, 1987. Mineral Economics: Decision-Making Methods in
the Mineral Industry, 5 - 17 July (Australian Mineral Foundation:
Adelaide).
Tilton, J E, 1985. The metals, in Economics of the Mineral Industries,
fourth edition (ed: W A Vogely), pp 383-416 (The American Institute
of Mining, Metallurgical, and Petroleum Engineers: New York).
Tilton, J E, 2003. On Borrowed Time? Assessing the Threat of Mineral
Depletion (Resources for the Future: Washington).
United States Geological Survey, 2003. Recycling – Metals, US Geological
Survey Minerals Yearbook 2002 (United States Geological Survey:
Washington). [online]. Available from: <http://minerals.usgs.gov/
minerals/pubs/myb.html>. Date accessed: 8 May 2006.
Western Australian Government, 2004. Western Australian Minerals and
Petroleum Statistics Digest 2003 (Western Australian Government,
Department of Industry and Resources: Perth) [online]. Available
from: <http://www.doir.wa.gov.au/documents/mineralsandpetroleum/
statsdigest2003.pdf>. Date accessed: 8 May 2006.
WMC Resources, 2005. [Online]. <http://www.wmc.com>.
Australian Mineral Economics
 CHAPTER 7

Mineral Markets, Prices and the Recent Performance of

the Minerals and Energy Sector
Phillip Crowson

Introduction
Market Structure – Competitive Markets
Market Structure – Oligopolistic Markets
The Rise and Fall of Cartels
Producer Pricing
Terminal Markets
Recent Trends in Mineral Markets

INTRODUCTION Leaving aside the complications flowing from the existence of

The two preceding chapters examined the diverse influences on
demand for mineral products and the various forces acting on the
supply side. In essence, prices are determined by the interaction
of these opposing forces in the market place. The geographical
location of demand, the end uses and the nature and sources of
supply differ for each product, and these differences in market
structure dictate precisely how demand and supply interact to set
the prices of individual products. The nature of the pricing
mechanism is strongly influenced by the ease with which new
suppliers can enter the market (in other words by the barriers to
entry). In the short to medium term price levels can be affected by
political, economic and social conditions in mineral-producing and
consuming countries, but the main factors are geological and
technical. Where ore deposits are readily discovered and easily
exploitable with existing technology at prevailing price levels the
barriers to entry are low. Conversely, a scarcity of exploitable
deposits keeps the barriers high. Changes in exploration or
extraction and processing technology can rapidly change the
conditions of entry.
MARKET STRUCTURE – COMPETITIVE MARKETS
Where the barriers to market entry are low there is likely to be
a relatively large number of suppliers. The more present and
prospective suppliers there are, the more competitive they are
likely to be with each other. Price in such competitive markets is
determined by the free interplay of supply and demand, and it
will fluctuate to the extent needed to clear the market. The
demand curve facing each individual supplier is, to all intents
and purposes, flat rather than downward sloping to the right like
the industry’s demand curve. Producers are price takers and
have little or no influence over the prevailing price. They can,
however, alter the amount they supply to the market, and each
supplier will produce as much as possible as long as their cash
costs are fully covered.
inventories, other than normal working stocks, prices will settle
in the near term where demand and supply intersect. Other
factors being equal, a rise in demand or a fall in supply will
prompt a rise in prices and a fall in demand, or a rise in supply
will prompt a fall in prices until equilibrium is restored. In
practice, prices will tend to fluctuate around the equilibrium
level, because conditions are continuously changing. Prices will
gravitate towards the industry’s marginal cost of production: the
cost of production of the last (or most expensive) unit of supply
from whatever source, which is required to balance the market.
The nature of the supply curve in competitive markets and its
interaction with demand and price are illustrated in Figure 7.1.
D1
P1
D
Price
P
D2
P2
Q2 Q Q1
Quantity
Capacity
FIG 7.1 - Short-run supply and demand in competitive markets.

Australian Mineral Economics 59

CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

When prices are very low there is no supply, as costs exceed developments by privately owned companies through much of
prices. Higher prices allow producers to cover their costs and the 1960-1990 period, especially where such companies were
enter the market until supply is constrained by the available foreign-owned. Many countries prevent the mining of known ore
capacity. Then no additional supplies can be immediately deposits in national parks or wilderness areas. Unstable political
forthcoming, no matter how high prices rise. It takes time for conditions increase the risks of mineral exploration in many
new capacity to be developed, whether that comes from the regions, but particularly in Africa and parts of Asia, to
expansion of existing operations or from new facilities. The price unacceptable levels. These various influences, either alone or in
and the quantity supplied settle at the point where the supply and combination, raise the barriers to entry and limit the number of
demand curves intersect (P and Q when the demand curve is D). producers.
If the demand curve rises to D1, higher cost producers will be As Table 7.1 illustrates, there are typically relatively few
able to supply and the price and quantity will rise to P1 and Q1. significant suppliers to the market for a wide range of minerals
Conversely, when demand drops back to D2 (perhaps because of and their first stage products. The table shows the shares of the
economic recession or some technological change in end-use largest firms in the global production of a range of mineral
markets) higher cost producers will be unable to cover their costs products, split between those that are traded in terminal markets
and price and output will fall to P2 and Q2 respectively. and those whose prices are fixed in other ways. Platinum appears
This assumes that suppliers merely have regard to near-term in both groups, as producers directly sell most production to
demand and prices. In practice their reactions will be much more users at list prices that lag terminal market prices. The degree of
complex. If they believe that a price fall is temporary they may industry concentration is a major influence on pricing, but not
be prepared to stockpile rather than reduce their output, or to the only one. Often there are also relatively few major users.
incur losses for a period. The costs of closure, including the
repayment of debt, environmental remediation and redundancy
payments, may exceed the costs of continued operation. Also, TABLE 7.1
many suppliers may have more complex objectives than short- Concentration in mineral markets: percentage shares of largest
term profit maximisation and may be prepared to produce at a firms in world production 2002. (Source: Raw Materials Group,
2004.)
loss. Over the longer term, when the constraint of existing
capacity is lifted, the supply curve will shift to the right, with its Leading Top 3 Top 5 Top 10
level dictated by technological change and shifts in the political
and regulatory climate. Metals traded on terminal markets
The non-ferrous metals, gold and silver, are the mineral Silver 8 22 29 41
products whose markets most closely approximate the Gold 9 23 32 47
competitive model. They are typical commodities, in the sense Platinum 42 76 89 98
that the products of different producers are reasonably
homogeneous and any individual supplier’s product can readily Copper metal (2003) 10 24 34 49
substitute for that of another. There are many customers and a Zinc metal 14 31 42 60
variety of end uses, each with common standards and Aluminium 13 32 43 60
specifications. Producers can exert little or no influence over the
Nickel 16 39 49 68
markets for their products, which are usually regional or global,
and there is hardly any after-sales service, such as technical Negotiated or list prices
support. Prices are uniform for the standard grades and the Zinc mine 9 23 30 43
producers concentrate on controlling their relative costs. There Lead mine 10 25 34 48
are many suppliers spread throughout the world and no single
producer can influence the level of prices, except for very short Copper mine 12 25 37 58
periods. There are many ore deposits being exploited or under Iron ore (2003) 18 37 46 58
development, it appears relatively easy to discover new ones, Manganese 9 26 36 52
secondary materials are readily available and transport costs are
Alumina 15 33 46 71
generally low relative to product prices. Information about recent
and prospective trends in supply and demand is rapidly and Bauxite 16 34 49 68
widely diffused and the markets are reasonably transparent. Chromite 21 49 64 83
That prices and volumes will settle at the unique point where Diamond value 29 64 76 82
the demand and supply curves intersect does not describe the
Titanium minerals 24 53 70 85
actual process of price discovery, except in an auction market.
There bids and offers are made in public until a price is derived Lithium 23 68 77 83*
that just clears the market. At that price all purchasers and Mercury (1997) 39 87 90†
suppliers are satisfied. The method is similar for gold, silver and
Niobium 40 83 94 98‡
the non-ferrous metals in that their prices are settled in terminal
markets. The characteristics of such markets are explained in a Platinum 42 76 89 98
later section of this chapter.
Notes: † top 4, ‡ top 7, * top 9.
MARKET STRUCTURE – OLIGOPOLISTIC
MARKETS Where there are only a few major producers the suppliers do
not have to take the demand curve as given and their actions can
The markets for most mineral products depart in varying degrees have some influence on prices. Rather than a demand curve that
from the competitive model. The geological availability of many is flat, they face one sloping downwards to the right, just like the
products is much more limited than for the non-ferrous metals or industry. As there are usually few suppliers the supply curve is
the technology needed for their extraction and processing is far likely to be stepped. Producers can exert some control, even if
more complex. The accessibility of ore deposits for commercial strictly limited, over the prices they receive by differentiating the
mining may be restricted by a variety of political, environmental characteristics of their products from those of their competitors.
or economic factors. For example, many developing countries In many instances there is considerable competition in the
either totally prohibited or severely circumscribed mineral non-price dimensions of the product, such as technical service or

60 Australian Mineral Economics

 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
delivery schedules. The chemical and physical characteristics of
the product are varied not just for particular end uses, but often
also for individual users. There is a wide variation in grades and
specifications, which is reflected in widely differing prices for
apparently similar products. The costs of mining the raw ore are
less important than its characteristics and the methods whereby it
can be modified to serve the end-uses that offer the highest
prices. Even producers of commodity metals and minerals look
for ways to upgrade and differentiate their products from those of
their rivals in order to achieve a premium over the basic market
prices. Their objective, which is sometimes attained, is to create
a market for their own output that is distinct in some way from
the market as a whole.
Where prices settle will clearly still depend on how and where
demand and supply intersect, no matter the precise structure of a
product’s market. Since the costs of most suppliers are lowest at
or near their maximum possible output they will tend to produce
to capacity. Without the safety valve of terminal markets
however, the costs of stockpiling excess supplies usually forces
suppliers to reduce their offerings in periods of weak market
conditions. The short run market conditions facing a
‘representative’ producer are shown in Figure 7.2. The shapes of
the demand and supply curves have been deliberately
exaggerated.
Marginal
Cost
Average
P Cost
Above-normal
profit
Price Demand
Marginal
Revenue
Q in selling their own grades can undermine established price
Quantity
FIG 7.2 - Short run market equilibrium for a ‘representative’
producer.
As the producer faces a downward-sloping demand curve for
output, the marginal revenue from additional sales will also
decline with increasing output. Assuming that the producer aims
to maximise profits, they will produce to the level of output (Q)
where marginal revenue equals marginal cost of production.
The price (P) is rather higher than would be set in a completely
competitive market and the producer would earn above-normal
profits. That is not a stable position because such profits would
induce a variety of competitive responses. Exploration and new
mine development would be stimulated and technological
research on lower-cost processes encouraged. On the demand
side, the use of substitutes would be encouraged. In consequence
the demand curve facing the ‘representative’ producer would be
pushed downwards, lowering the level of output associated with
a given level of prices. Subject to the ease or difficulty with
which the barriers to entry could be surmounted the excess
profits would eventually be eliminated by competition and the
long run equilibrium shown in Figure 7.3 would be attained.
The producer would still maximise profits at the point where
marginal cost equalled marginal revenue, but with only a
‘normal’ rate of profit. Also, the level of output would be rather
lower than would be reached in a perfectly competitive market,
were that to exist in the real world. As markets develop, and the
number and range of producers expand, prices drop towards the
Australian Mineral Economics
Marginal
Cost Average
Cost
P1
Price Demand
Marginal
Revenue
Q1
Quantity
FIG 7.3 - Long run market equilibrium for a ‘representative’
producer.
marginal costs of production and any monopoly profits are
gradually whittled away. The theoretically relevant marginal
costs are those likely to pertain over the long run. In other words,
they will incorporate the opportunity costs of capital of the
facilities just needed to meet expanding demand over the long
term. In practice prices tend to gravitate, at least in the
competitive markets, towards the cash break-even costs of
existing marginal producers. New entrants will aim to have much
lower cash costs than these and to cover their full costs at
expected prices.
Markets with only a few suppliers are described as oligopolies,
and those with only a few customers, are given the less common
description of oligopsonies. In many such markets there may be
a penumbra of smaller suppliers or users around the few large
firms. Small customers are liable to absorb an unduly large
amount of time and effort from the suppliers’ sales staff and they
are often serviced through distributors. Although small producers
are unlikely to produce a full range of products, their persistence
structures. Major suppliers of many industrial minerals and
minor metals therefore have to take full account of their activities
and potential actions. The power of the major producers to
control their markets is accordingly circumscribed. In all cases
each producer has to take account of the possible impact any
decisions about pricing and production volume may have on
competitors and of their likely policies. How those differ will
partly depend on each producer’s relative costs and available
capacity.
In some instances the smaller producers may sell through
merchants, who may also acquire supplies from other sources.
These may include releases from redundant government
stockpiles, scrap and secondary recovery and in previous times
imports from state trading countries that were on the fringes of
the global market economy. Particularly when market conditions
are weak, merchants have been able to re-purchase excess
supplies from the customers of the major suppliers. Although the
producers naturally discourage resale of their products, they
cannot always prevent it.
At the theoretical extreme of a market with just one supplier,
or pure monopoly, the demand curves of the supplier and the
industry are the same. Monopolists can choose that combination
of price and volume that best suits their objectives. Assuming
that their objective is profit maximisation they will produce to
the point where the marginal revenue equals the marginal cost.
The short run position shown in Figure 7.2 would hold for the
monopolist over the long run. In practice there are no instances
of natural total monopoly in the mineral industries on a global
scale, although there have been cases of contrived monopoly
61
CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
through cartels and similar collusive actions in restraint of trade.
The availability of secondary materials and of substitutes of
varying degrees of effectiveness for most mineral products
means that any individual supplier’s power to raise prices by
holding back supplies is strictly limited.
That substitutes exist and that there are usually competing
suppliers to global markets does not rule out the probability of
more restricted monopolies. The key is the height of any barriers
to entry. These can be artificially raised for domestic producers
in a national market by protection against imports through tariffs
or quotas. Over the post-war years there was a steady trend in all
major economies towards dismantling quotas and other
quantitative restrictions and lowering tariff barriers on most
products. This gradually eroded local monopolies, often against
the strong resistance of the previously favoured suppliers. Some
developing countries still have highly protective tariffs against
imports, although there are continuing pressures for their
reduction. The cost of transport provides a less penetrable
barrier, especially for bulk products with a low value to weight
ratio.
Accordingly, the markets for sand and gravel remain largely
local, even in the US and Western Europe. For bulk products like
coal and iron ore, however, sharply declining costs of ocean
shipping during the decades following the Second World War
opened up local and national markets to international
competition, which had consequent repercussions on the market
structure and pricing of such products.
As demand for a product develops and expands from its initial
niche markets, new entrants are attracted over the prevailing
barriers to entry. The more suppliers there are, the more difficult
it becomes for any one of them to control, or even influence,
prices. In the initial stages of a product’s life cycle there may be
only a limited number of uses, or perhaps only one. Users will be
prepared to pay high prices to satisfy their needs. The owners of
the more accessible deposits are able to cream off monopoly
profits, especially where they also control innovative processing
technology. These profits naturally attract the envious attentions
of other companies, stimulating both exploration and research
into processes. Often both are successful and the initially high
barriers to entry are reduced.
New entrants can piggy-back off the marketing activities of the
initial pioneers. Capacity expands, probably at a faster rate than
demand, which remains dependent on specialist uses. Sooner or
later potential supply exceeds demand and prices come under
pressure. The initial producers will have probably recouped their
investment several times over and be prepared to drop prices both
to stimulate demand and to choke off new entrants. Conversely,
the latter may be forced into price cutting in order to gain market
share. Often they may be able to withstand lowered prices
because their deposits or processes are superior to those of the
pioneers. Normally production starts at those deposits that are
known or readily accessible, rather than at those with the
potentially lowest costs. Followers building completely new
facilities may be able to exploit process improvements more
easily than the originators in their established plants.
Military needs in wartime have often forced large increases in
the capacity to produce many mineral products and metals, often
irrespective of profitability. The physical need has been
paramount. When military demand has dropped, producers have
been forced to develop new uses in order to keep their capacity
running, often with price reductions. Changing technology has
also been a driving force. In all cases rapidly expanding markets
have allowed producers to exploit economies of scale.
The ways in which market prices, other than those fixed in
terminal markets, are actually determined varies widely between
different mineral products. Prices for some are posted by
producers, almost on a ‘take it or leave it’ basis. Such producer
pricing, which is discussed later in this chapter, was once much
62
more widespread. In effect, the producer acts like a monopolist,
offering to sell at a given price, with an implicit assumption that
output will be reduced to maintain that price when market
conditions are weak, and that some customers may be unsatisfied
when demand runs against the limits of capacity. Other producers
may voluntarily decide to follow the lead set by the price-setting
producer and accept satisfactory rather than maximised profits.
In other instances producer pricing may be sustained through
collusive behaviour, ranging from informal discussions to formal
cartels. The recent history of cartels is also described later in this
chapter.
Where there are only a few major participants on each side of
the pricing equation (which is true for many mineral products)
prices are largely determined by negotiation. Each participant
has to take account not only of the likely responses of the
customer to their actions, but also of the possible reactions of
existing and potential competitors. Such intelligence is usually
more important for the producers than the purchasers. Each
mineral product effectively forms a small village where all the
major participants know each other. This village-like nature of
global mineral markets facilitates the rapid transmission of
gossip and information and the sense of prevailing market
conditions, even where there is no explicit market place.
How companies behave when negotiating prices largely
depends on the point reached in the business cycle and on the
strength of any barriers to entry. A tougher negotiating stance is
more appropriate when markets are tightening than when they
are in the recessionary phase of the cycle. Where there are few, if
any, viable undeveloped ore deposits, or where complex
proprietary technology is required in the production process, the
existing producers’ bargaining position is strong. It weakens
markedly where there is ample existing and prospective capacity
and technology is readily available.
Thus the differing availability of ore deposits probably favours
manganese producers over iron ore producers in their dealings
with the steel mills. Neither has a very strong position however,
compared with the existing producers of titanium dioxide
feedstock during the 1980s and early 1990s. They benefited from
high barriers to entry in both ore reserves and technology. Their
market power was constrained by the comparative strengths of a
few large purchasers. Mutual deterrence is as much a feature of
some mineral markets as of international relations.
History suggests that price wars, once started, are difficult to
stop and that they normally benefit only the customers. Even that
benefit may be strictly short term if lower prices inhibit
investment in additional capacity to meet growing demand.
Much depends on whether the major producers concentrate their
attention on maximising prices and profitability, or on volume.
The pursuit of market share is a common corporate objective,
on the assumption that it can enhance a company’s market
power. It does not usually appear to have been accompanied by
long-term profitability when it has been followed in the minerals
industry. One possible argument in favour of maximising
volume, even at the expense of weaker prices, is that it enables a
producer to achieve the designed economies of scale from
existing capacity. The structure of costs may be such that the
burden of fixed costs per unit of output rises sharply when the
mine and equipment are not fully utilised. The gains from
increasing the volume of sales may more than outweigh any fall
in prices.
Trade-offs like those are typical of the iron ore producing
industry. Producers of iron ore, like those of other minerals,
never look solely at one dimension of their sales contracts but at
them all simultaneously. Concessions on price may be set against
increased volume, but these are not the only dimensions of sales.
Quality, including such features as the grade and the physical and
chemical composition of the ore, is becoming increasingly
important. Quality involves far more than the ore itself. The
Australian Mineral Economics
 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
perceived reliability of a supplier and its susceptibility to strikes
and other disruptions is another aspect of quality. The provision
of technical service to customers is not really important for the
producers of metallic ores, but it can be a valuable competitive
tool for suppliers of industrial minerals. The terms on which
credit is granted to purchasers and the extent to which prices may
vary with the prices of the customer’s products are also relevant,
especially in the markets for base metals concentrates.
In iron ore and coal, as in many other products, pricing has
evolved over the past 30 years. When many exporting mines
were first established, trade was mainly based on long-term
contracts with prices fixed over long periods or indexed to
general indicators according to agreed formulae. Such contracts
have evolved into shorter term contracts covering several
years, but with periodic price negotiations. The volumes can also
vary within predetermined limits, depending on market
conditions. Negotiations do not start from scratch every year, but
from the prevailing prices, which roll over until a new agreement
is reached. In some product markets, and especially in industrial
minerals, prices are negotiated for the life of the contract, which
may be for three to five years. Provision may be made for prices
to move over the life of the contract in step with agreed indices,
such as US wholesale prices. When the contracts expire, the two
parties will negotiate a new agreement taking into account
changes in the balance between supply and demand and the
extent to which the expiring contract favoured one side or the
other. Very often one party will be keen to offset any
disadvantages it suffered during the previous contract term.
Usually agreement is eventually reached because there is a
mutual interest in a continued relationship, but discussions
occasionally break up in acrimony, with the parties resorting to
arbitration.
More frequent negotiation of prices tends to prevent such
disruptions since contract prices then move more closely with
market conditions. Sometimes prices are changed half-yearly or
even quarterly, as in sulfur and some fertiliser materials. Annual
price negotiation is now the general rule in iron ore, coal and
base metals concentrates. Large producers may divide their
contractual volumes, even with one customer, into blocks whose
prices are negotiated at different times. That softens the impact
of any large price movements resulting from the annual
negotiating round. The outcome of the annual bargaining
naturally depends on the relative strengths of the buyers and
sellers, but also on the changing objectives of individual
producers. The first major price settlement reached in the annual
bargaining round usually sets the tone for the entire market and
other suppliers quickly follow. The same supplier and customer
may lead the market for several years running, but the leadership
often changes. Published prices are normally only one facet of a
settlement that also includes arrangements on tonnage. The
producer that settles first in a weak market may have
counterbalanced concessions on price with increased sales
volumes, but the followers seldom derive those benefits.
Participants in the market have to weigh up all the alternatives in
their negotiating strategies. Obviously they will need to take
account of the size of their own and their competitors’
inventories and of the balance between the capacity and output of
each producer. Eventually a global consensus about prices is
reached and prices in the main regional markets are closely
linked. Sometimes such a consensus is reached quickly, whereas
in other years the negotiations can drag on for months.
THE RISE AND FALL OF CARTELS
Even where prices are negotiated between major producers and
users of a product, there may be scope for collusive action
between producers. Adam Smith (1976) [1776] remarked on this
tendency over 200 years ago:
Australian Mineral Economics
People of the same trade seldom meet together,
even for merriment and diversion, but the
conversation ends in a conspiracy against the
public, or in some contrivance to raise prices.
The same factors that facilitate producer pricing – namely a
relatively limited number of producers – tend to encourage
restrictive agreements to limit output or raise prices. The history
of the minerals and metals industry is littered with attempts to fix
prices through cooperative actions. These have met with varying
degrees of success, but most have ultimately failed. Some have
worked through producer pricing whilst others have operated
through terminal markets. Many, but by no means all, were
started in periods of over-supply as defensive reactions to
self-defeating price cutting. Those were often introduced with
the active support of or at least implicit connivance of,
governments.
Attitudes to cartels between producers are much affected by
prevailing political philosophies. During the period between the
First and Second World Wars, many governments accepted the
need for concerted action to restrict output in conditions of acute
excess capacity and weak demand in order to sustain prices.
In the decades following the Second World War such attitudes
persisted and they were reinforced by the widespread acceptance
of government intervention and regulation of economic activity.
The Organisation of Petroleum Exporting Countries
(OPEC) was one of many producer-based organisations
established during this period. It was founded in 1960 by five
countries, Iran, Iraq, Kuwait, Saudi Arabia and Venezuela and a
further eight oil producing countries had joined by 1973. For the
first decade of its existence OPEC achieved very little, but its
members chipped away at the power of the international oil
companies that effectively controlled their production. Strongly
rising international demand for crude oil, partly driven by the US
moving from a production surplus to a deficit, enabled the
producers to achieve moderate price increases in 1971. The
Arab-Israeli war of October 1973 and its aftermath encouraged
OPEC to go much further in gaining control of pricing and
production. The move was driven by political rather than
economic considerations, as a means of putting pressure on the
industrial countries. The price of oil quadrupled, transforming
the international oil market and prompting serious economic
dislocation in the global economy. The Iranian revolution in
1979, coupled with political upsets elsewhere, led to a further
round of sharp price rises in 1979-80.
The initial price increases held because the short run demand
for oil was highly price inelastic, but by the early 1980s
alternative sources of oil were being developed, partly under the
stimulus of the higher prices then ruling. There had also been
wholesale substitution away from oil to alternative fuels and
energy-saving measures of all types. By the late 1990s OPEC
supplied about two-fifths of the global production of crude oil
compared with well over half in the early 1970s. Although OPEC
introduced formal quotas on production in 1982 in order to
sustain prices, there was widespread cheating and crude oil
prices drifted downwards from the mid 1980s. The first Gulf War
in 1991 had but a temporary impact on oil prices.
By the late 1990s global demand was again starting to outstrip
the available capacity to produce and OPEC’s production quotas
became more effective. The collapse of Iraqi production in 2003
helped OPEC to sustain crude oil prices. Most of the surviving
members of OPEC (Ecuador left in 1992 and Gabon in 1995) are
Islamic states with a similar political outlook, although the
similarities between theocratic Iran, a feudal monarchy like
Saudi Arabia and Nigeria or Indonesia should not be overstated.
OPEC’s successes have sprung not so much from its own policies
and actions as from the global market conditions it faces.
OPEC’s share of world oil production between 1965 and 2004 is
shown in Figure 7.4.
63
CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

100
Where costs of production diverge widely there is little
OPEC Non-OPEC community of interest between the lower and higher cost
80
producers. Similarly, a wide diversity of sources of production
and undeveloped reserves raises the prospect of new entrants
million barrels/day

60 undermining the cartel. In essence, the barriers to entry need to

be fairly high and not just in the short run. There should be few
40
viable substitutes in the product’s major uses and the
price-elasticity of demand should be very low.
Even during their heyday in the late 1970s, producer
20
associations formed merely to increase or stabilise prices were
unlikely to succeed, because some or all of the necessary
0 pre-conditions for success were lacking. Table 7.2 outlines the
1965 1970 1975 1980 1985 1990 1995 2000 fate of several international producer groups that were formed or
A gained prominence during the 1970s.
60
Bauxite was perhaps the nearest parallel to petroleum in the
early 1970s and producing countries such as Jamaica raised their
50
returns from local bauxite production. That was a temporary
success however, because there were ample alternative resources
% share of world total

40
30
20
10
0
1965 1970 1975 1980 1985 1990 1995 2000
B inter-governmental producer groups that were formed during the
FIG 7.4 - (A) World crude oil production and OPEC’s share of
world production. (Source: British Petroleum, 2004 – the data
cover crude oil, shale oil, oil sands and natural gas liquids).
(B) OPEC’s percentage share of world oil production.
OPEC’s apparent success in raising crude oil prices in the
early 1970s prompted the formation of similar international
producer groups for a variety of mineral products, such as
phosphates, bauxite, iron ore, mercury and tungsten. Less formal
arrangements covered manganese, lead and zinc. Many groups,
nominally at least, excluded any discussion of prices from their
agenda. The articles of the World Phosphate Institute, for
example, were framed in such a way as to leave the three US
company members free of any anti-trust action. Australia only
joined the bauxite and iron ore associations on the understanding
that they would not attempt to increase prices unilaterally.
Nonetheless, the smoothing of price fluctuations was always an
important objective of most members of all these producer
groups and of the copper producers’ group, CIPEC, which was
formed in 1967. Most were inter-governmental bodies, although
the phosphate, mercury and tungsten organisations had
individual company members. Most lacked the wider common
interests that created the strong cohesiveness of the Arab
members of OPEC. Weak market conditions from 1974 onwards
prevented most producer associations from exploiting any power
they might have had. In any case, the basic economic conditions
that allowed OPEC to boost oil prices do not exist in most
commodities.
There are several preconditions for successful cartel action:
• members should share some common interests and objectives;
• there should not be a wide range of grades or qualities of the
product involved, but different producers’ output should be
closely substitutable (the scope for cheating tends to vary
inversely with the homogeneity of the product);
• a high level of concentration of production and reserves is
required; and
• the cost structures of each producer should be broadly
comparable.
and the barriers to entry were relatively low. The raising of prices
provided leeway for potential producers in other countries such
as Brazil to develop new mines. Jamaica’s share of global
bauxite output fell from around 18 per cent in 1973-74 to eight
per cent by the mid-1980s.
Morocco and the other members of the putative phosphate
cartel were unsuccessful in sustaining their price increases
because farmers effectively went on strike and delayed the
application of phosphatic fertilisers. Many of the
1970s did not survive changes in market conditions and
prevailing political philosophies. The International Bauxite
Association, for example, saw a gradual loss of members before
collapsing in 1995. In copper, CIPEC saw many members
withdraw and contracted, leaving its residual coordinating
functions carried out in Chile.
Even if the necessary preconditions for cartels had been in
place, the marked change in global political conditions that
gathered force during the 1980s would have made their lives
difficult. The emphasis moved from collective to individual
action and to the primacy of market forces. Government
intervention became unfashionable with the view that prices
should be allowed to find their own levels in response to
competitive forces, which should be facilitated by effective
competition policies.
A major defect of producer cartels is that they do not explicitly
take account of the interests of consumers. Governments of
commodity-consuming countries are, therefore, wary of their
creation, especially where companies rather than governments
are involved. Both the US and the European Union came out
strongly against any effective cartels, whether these were
organised by individual producing companies (private or state
owned) or by governments. This opposition was less than total,
however, as the United States has explicitly allowed cartels that
enable US exporters to compete internationally. Thus US
exporters of phosphates and soda ash combine to sell in overseas
markets. Similarly, joint purchasing arrangements amongst
consuming companies are also acceptable. Examples include the
Japanese smelter pool, which arranges imports of copper
concentrates and joint purchasing by both the Japanese and the
German steel mills. One company may take the lead in dealings
with producers, with the ensuing agreement shared by all. Joint
purchasing can tip the scales in the purchasers’ favour, even
where they have an apparently weak initial bargaining position.
Until the mid-1970s only the US had strong anti-trust
legislation and non-US companies were prepared to collude to
maintain prices. The important proviso was that such collusion
did not affect US commerce, otherwise it would have brought
those involved under the reach of the extra-territorial provisions

64 Australian Mineral Economics

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TABLE 7.2
International producer associations in the minerals industry.
Bauxite International Bauxite Association (IBA)
Formed March 1974 and by 1975 members controlled 85 per cent of non-socialist world output. Jamaica, Surinam, Dominican
Republic and Guinea successfully raised bauxite mining taxes, but Australia did not. The countries that did lost market share and the
IBA became increasingly ineffective. Jamaica withdrew in mid-1994 and the IBA collapsed in 1995.
Copper Conseil Intergouvernmental des Pays Exportateurs de Cuivre (CIPEC)
Formed in June 1967 by Chile, Peru, Zaire and Zambia. Yugoslavia and Indonesia joined later and Australia and Papua New Guinea
became associates. In 1974-76 CIPEC unsuccessfully tried to stabilise copper prices through production cuts, but its members
controlled too small a share of the global market. CIPEC dwindled in importance with the collapse of Central African copper
production, the withdrawal of several members and the establishment of an International Copper Study Group in 1993. Its residual
coordinating functions moved to Chile’s Copper Commission.
Iron ore Association of Iron Ore Exporting Countries (APEF)
Developing country members pressed for attempts to set export prices in 1975, but Australia and Sweden refused. Neither Brazil nor
Canada joined. APEF collected statistics on market trends until its suspension in 1989. Its statistics gathering role was taken over for
a period by an UNCTAD Trust Fund.
Phosphate rock World Phosphate Rock Institute
Morocco, the leading producer outside the USA, joined with Algeria, Brazil, Jordan, Senegal, Syria, Togo and Tunisia in 1973.
Morocco sharply raised export prices in 1974 and several other members followed suit. The United States’ export cartel, Phosrock,
also raised its prices. The global market collapsed in 1975 when the effects of recession were exacerbated by farmers ceasing to
apply phosphatic fertilisers.
Mercury Mercury Producers’ Association (Assimer)
Formed in 1975 by Algeria, Turkey, Mexico, Italy, Spain and Yugoslavia. Most production was state-owned. In late 1977 Assimer
announced attempts to control the market with sales restrictions, followed by price increases. Its control was undermined in 1982 by
falling consumption, increased secondary supplies and sales from US stockpiles, but was reasserted for a brief period in the late
1980s. Growing concerns about the adverse impact of mercury on human health and the environment have led to even tighter
regulations on consumption. These have also boosted recycling and greatly reduced any pricing power of the primary producers.
Tungsten UNCTAD Committee on Tungsten, Primary Tungsten Association
International Tungsten Industry Association
An Ad Hoc Committee on Tungsten, an inter-governmental body, was established under the auspices of the United Nations in 1963.
One of its tasks was to examine ways of stabilising prices. In due course, the Committee and its various offshoots moved under the
UNCTAD umbrella. Its main role was the collection of statistics but it also attempted to reach agreement on means of stabilising the
market, especially during the late 1970s. It was complemented by a producer organisation, the Primary Tungsten Association (PTA),
established by major producing companies in 1976. With changing attitudes to market intervention, the UNCTAD Committee was
replaced in October 1992 by an Inter-governmental Group of Experts on Tungsten, whose remit was solely statistical. The PTA was
replaced by the International Tungsten Industry Association in early 1988. This brought together mining companies, processors,
consumers and traders in a research organisation under Belgian law.

of the US anti-trust laws. It was reasonable to assume that
producer pricing outside the US was beyond reach as long as the
US was self-sufficient in the affected products. Imports into the
US of many minerals and metals began rising strongly in the
early 1970s however, for a variety of different (usually specific)
reasons. That led the US Department of Justice to examine
possible breaches of anti-trust laws by foreign companies.
Simultaneously, the European Union’s competition policy was
being developed and enforced through case law.
International zinc producers were amongst the first to
experience the changed climate. Companies who had established
and maintained the well-publicised European Producer Price
system for zinc from 1964 onwards with the tacit approval of
their host governments were questioned by the US anti-trust
authorities in 1976 and a case was brought against them by the
European Competition Directorate. That eventually resulted in
fines and the effective collapse of the system of zinc producer
prices, which had been enforced through an agreement to
stockpile, intervene on the London Metal Exchange and reduce
output when necessary. The vestiges of the system lingered on
for some years, but without the previous effectiveness. Even
when it was fully operational those involved in the system had
been quite prepared to cheat their colleagues if they could. Also
during the late 1970s the European Competition Directorate
successfully prosecuted a group of companies who had
collectively purchased all exports of aluminium from Eastern
countries in order to keep them off the London Metal Exchange
and damage the prevailing producer price structure.
These actions, and others in different industries, made
suppliers of minerals and metals into North America and the
European Union much more careful about the anti-trust rules.
For example, the major aluminium producers took great pains to
involve governments in ways of tackling the problems raised by
the sudden and unexpected outflow of aluminium metal from the
former Soviet Union in the late 1980s and early 1990s. The
Memorandum of Understanding signed between Russia and
certain major aluminium-producing countries in early 1994 was
an inter-governmental agreement. It provided a fig leaf behind
which the companies could shelter when they cut their output in
order to restore market balance. Those cuts coincided with an
influx of speculative funds into purchasing non-ferrous metals,
especially aluminium. During 1994 prices rose sharply, by far
more than anyone had forecast, and some aggrieved users of
aluminium attempted to sue the US producers for anti-trust
violations.
The diamond market provides the longest running example of
a price setting cartel that has been treated as unlawful in the US.
For many years De Beers operated an effective cartel amongst
the mining countries and controlled market prices through its
sales policies and by stockpiling. The US anti-trust authorities
were strongly antagonistic and would have prosecuted both the
company and its officers had they ever been within US
jurisdiction. That was not however, a sufficient impediment,
notwithstanding the considerable funds that had to be raised to
finance stocks during periods of weak demand such as the early
1980s and early 1990s. The collapse of the Soviet Union in 1991
and the development of new mines outside De Beers’ control
weakened its influence. Australian production, mainly of
industrial diamonds, began in the early 1980s and the Australian
producers became increasingly assertive towards the De Beers
Central Selling Organisation. Gradually De Beers’ tight grip on
global diamond marketing weakened, especially with the start-up
of Canadian production in 2001. A considerable degree of
market discipline remains however, largely because of the nature

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of the market for diamond gems. Consumers, perhaps even more
than producers, have an interest in maintaining high prices for a
product whose value is as a status object rather than for its
intrinsic properties in use. If the global diamond market is
cartelised, it is a cartel in which consumers are as guilty of
conspiring as producers. That makes diamonds very much a
special case. Even in diamonds, a form of producer pricing does
not eliminate the need for careful analysis of market trends, for a
willingness to stockpile, or for a need for production cutbacks in
periods of weak demand.
Notwithstanding strong anti-trust legislation in major
minerals-consuming countries, collusive actions to restrict
competition persist. In 2003 for example, the European Union
fined European producers of copper tube for price fixing. It also
began an investigation into the copper concentrate market jointly
with the relevant Canadian and US agencies. There were
suggestions that meetings to discuss market conditions and
industry statistics provided a front for price fixing. The
investigations were eventually dropped without any actions being
taken. The nature of the markets for minerals and their first-stage
products means that producers will always seek ways of
restricting competition. The search inevitably intensifies during
prolonged periods of weak market conditions. Most collusive
agreements are likely to prove temporary because demand is not
sufficiently price inelastic over the medium to long term and
because the barriers to entry are not high enough.
PRODUCER PRICING
Collusive action of any type is not a pre-requisite of producer
pricing. Where there are only a few suppliers to a market but
many end-uses and customers, producers may quote list prices.
Such producer prices may be set by a dominant producer or
price leader and followed fairly closely by the other suppliers.
They may have similar cost structures and have learned from
bitter experience that vigorous price competition brings only
temporary gains in market share that are usually whittled away in
the next round of price cuts, to the benefit of users rather than
producers. Concentration on the other competitive dimensions,
such as product quality, marketing or technical service, may be
more effective means of attracting and retaining customers.
Where producers set prices they tend to keep them fixed for
long periods. They often set them not by reference to marginal
costs, whether their own or those of the industry, but to some form
of average cost. Prices change in response to clear external
stimuli, like movements in the costs of major raw materials such
as crude oil. They are also responsive to their setter’s financial
needs and changes in productive capacity, which often go together.
Customers claim to like producer prices because of their
apparent stability and their air of predictability. The infrequent
changes enable consumers to plan ahead with confidence,
especially where their purchasing is subject to annual cash
budgeting. That has been the typical pattern not just for
state-owned companies and government departments but also for
major purchasers such as automobile producers. In the
immediate post-war decades, producers set prices for most
minerals and metals and true market-related pricing was
relatively rare.
The stability of producer pricing was (and is) more apparent
than real. It is impossible to maintain complete control over both
prices and the volume purchased, except under total monopoly.
No matter how clever the forecasters, there are always
unexpected changes in the balance between supply and demand.
Stable prices are only realisable where suppliers are prepared to
reduce their offerings when markets are over-supplied and to
expand their offerings rapidly in times of shortage. That in turn
means a willingness to stockpile and even reduce production in
weak markets and to raise output rapidly in the boom. This
implies that there will be a degree of over-capacity throughout
66
most phases of the business cycle, which in turn means that
really effective producer pricing is only achievable in those
markets where there are only a few strong companies. High
barriers to entry into the market and a perceived community of
interest in price stability between the suppliers are usually
preconditions for success.
Producer pricing has been strongest and most tenacious in
national or regional markets that are protected in some manner
from imports. The basic cost structures of producers within one
country may differ, but they are subject to similar variations in
costs and demand and to a common regulatory framework. Often
the producers of the primary materials may be integrated with
downstream users of their products. That means that the actual
price of the raw materials is not of great importance, but it
merely indicates where profits are recorded for accounting
purposes. The tax authorities will have some interest in ensuring
that transfer prices between the various stages are not being
used to evade taxes, but that need not impinge on market prices.
The list prices for the raw materials may only be paid on the
modest portion of sales, often to small users, made outside the
integrated network. That was the case in the US primary
aluminium industry and largely still is. The prices of
semi-fabricated products are infinitely more important to the
major US aluminium producers than the price of ingot. The
progressive reductions in tariffs and other barriers to trade
between major metal producing and consuming countries in the
1960s and 1970s lowered barriers to foreign competition and
made the defence of domestic producer prices much harder:
prices could be more easily undercut by imports.
Even where producers are able to tailor their production to
fluctuating demand, the fit will rarely be perfect. Individual
producers may be unable to bear the burden of financing large
inventories, even with accommodating financial institutions.
When markets are weak for extended periods the patience of
such institutions soon becomes strained and their willingness to
grant additional credit distinctly limited. Hence, recourse has to
be made to production cutbacks, which are seldom easy to
engineer unless one supplier is prepared to shoulder the entire
burden. Individual producers may believe that they have an
inherent cost advantage that enables them to carry on producing
at a profit when others make losses. They may expect an
imminent improvement in market conditions, or they may be
loath to countenance any drop in market share that might flow
from their cutbacks. This all means that collusion between the
suppliers has often been necessary to ensure the appropriate
cutbacks. This might be no more than following the example set
by a dominant market leader, such as International Nickel in
nickel, or the former Amax in molybdenum. More than that
invites a legal riposte. The US has long had legislation
prohibiting collusive action in restraint of trade, but the diligence
with which it has been enforced has varied. The legal sanctions
include possible imprisonment of those individuals found guilty
and the threat of triple damages for any aggrieved parties.
Even where producers’ published list prices have been
apparently stable for long periods, the prices at which business is
actually transacted can diverge markedly. Large customers may
enjoy volume discounts that rise when market conditions
deteriorate and other forms of incentive then creep in. When
demand presses against the limits of capacity and redundant
plant has been brought into service premiums may be imposed
on groups of customers, or even on all. Moreover, rationing will
sometimes be introduced, with long-established customers
favoured over casual trade. That naturally creates a constituency
amongst the aggrieved parties in support of potential new
entrants. It was International Nickel’s inability to supply nickel
during a strike in 1969, and the ensuing acute shortages, that
triggered a massive exploration boom and the subsequent
development of new mines elsewhere. That in turn undermined
International Nickel’s hold on the nickel market.
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 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
Typically producers’ list prices have tended to rise over time,
at least in money terms, with cost-justified, or market-driven,
increases much more common than price cuts introduced when
conditions are bad. The burden of those is taken more on
volumes supplied. The benefits of productivity improvements of
all types are not fully passed on to customers, except when new
entrants threaten to undermine the established order. Indeed,
effective producer pricing may discourage suppliers from
pursuing productivity as aggressively as those who are forced
continuously to lower their costs to survive in periods of falling
market prices. The inherent discipline of market pricing is one
reason why producers always nostalgically incline towards
producer pricing.
The ability of producers to set prices has been gradually
weakened not just by trade liberalisation but also by the spread
of demand away from its traditional locations, and by the
development of new facilities to meet that rising demand. In the
immediate post-war decade the US was the dominant producer
and user of minerals and metals, and prices were heavily
influenced by the actions of US companies. Gradually, first
Western Europe, then Japan and more recently other countries,
emerged to challenge the US hegemony. Simultaneously, the
nationalisation of foreign-owned mines and processing plants by
many countries, particularly (but not exclusively) in the
developing world, weakened the ability of US companies to
control supply. The newly state-owned companies were often
mainly concerned with maximising their throughput and revenues.
Also, new mines and plants were established in developing
countries, often by state enterprises. These lacked any established
marketing experience and they were initially content to sell
through merchants, who could grant credit as well as obtain access
to markets. Aluminium was far from alone in this regard, although
investment in new aluminium smelters was stimulated by the oil
price rises and changing energy costs of the 1970s.
Another nail in the coffin of producer prices for products that
are produced and sold in a range of countries was the collapse of
the post-war system of fixed exchange rates that culminated in
the devaluation of the US dollar in 1971. This ushered in a
regime of floating exchange rates that was initially
accompanied by rampant cost and price inflation. Although
currencies could (and did) change their parities under the regime
of fixed rates, such changes were infrequent. The prevailing
assumption, broadly justified by experience, was of stability.
Nearly all producer prices were denominated in US dollars,
which had been regarded as a completely stable yardstick.
Floating exchange rates soon undermined that faith and
contributed to diverging interests between producers with
different currencies, let alone between them and consumers.
What was a stable price in one currency was not necessarily
stable in another, which meant that fixed dollar prices no longer
provided unequivocal signals about the changing balance
between supply and demand. Producers with appreciating
currencies saw their receipts shrink in their own currencies,
sometimes even when dollar prices rose. Conversely, those with
devaluing currencies saw their domestic revenues rise even when
markets were oversupplied and dollar prices eased. The stability
of producer pricing, and hence one of its basic rationales, was
undermined. Domestic prices still diverge even when global
prices are market-determined and currencies fluctuate, but no
one has ever claimed that market-driven prices are stable.
A summary of the history of producer pricing in non-ferrous
metals appears in Table 7.3.
Collusive action to fix prices has long been illegal in the US,
but overseas markets had not been subject to similar anti-trust
legislation. That changed during the early 1970s, with the
development of the European Union’s competition policy. As
discussed in the previous section, anti-trust actions forced the
Australian Mineral Economics
TABLE 7.3
The history of producer pricing in major non-ferrous metals.
Aluminium: The US Producer Price (Alcoa) was dropped in 1986.
Alcan’s World Price was the yardstick for pricing outside the US to the
end of 1988. It co-existed with various free-market quotations. LME
pricing began in 1979 and progressively superseded producer pricing.
Copper: Central African and Chilean producers set a producer price
between 1961 and 1966, when it collapsed. Most sales outside the US
have subsequently been based on LME prices. Within the US producer
pricing continued until well into the 1980s.
Lead: Within the US posted producer prices persist, but the vast
majority of the lead industry has long used LME prices as their pricing
basis.
Nickel: International Nickel posted its world producer price until
December 1987. LME quotations began in late 1978. For much of the
1970s there was heavy discounting from posted producer prices, and
free market prices were more reliable guides to transaction prices. LME
quotations now dominate.
Tin: Prices in the London and Penang markets, which were the basis of
most trade in tin, were effectively controlled by the operations of the
International Tin Council (ITC) between 1956 and October 1985. With
the collapse of the ITC, prices became entirely market-determined.
Zinc: Most global business is now based on LME prices. Within the
US producers posted prices until 1993. Elsewhere most producers
nominally used the International Producer Price from its inception in
July 1964 until its final demise in 1988. Its hold weakened from the
mid 1970s, as described in the main text.
demise of the European producer pricing system for zinc during
the late 1970s. It was, however, already suffering from
differences of interest between the different suppliers. Given its
fungible nature, there is nothing to distinguish between metal of
a given quality from different producers. Some are fully
integrated from mine to refinery, whereas others are not. Custom
smelters face a fluctuating market for their raw materials as well
as for their products. Costs of production, responsiveness to
fluctuating exchange rates and ability to vary output varied
widely between producers. There was no long-term community
of interest between the different producers that would persuade
them to tailor their supply to demand for long periods, or to build
up their own stocks rather than sell into the market, and cheating
was rife. There was a tendency to set producer prices at a high
enough level to placate the least efficient producer. That
discouraged consumption and provided scope for the more
efficient to expand. It also eased the path for new entrants who
may have been outside the system. Excess capacity inevitably
resulted. The aftershocks of the collapse of producer pricing
reverberated around the zinc industry for years.
There was always a tendency for all producer prices to be too
inflexible in response to changing market conditions and over the
long term to be set too high. The world copper producer price of
the late 1950s and early 1960s probably accentuated the
over-supply of the early 1960s. The European zinc producer
price and the stable nickel producer prices of the 1970s also
tended to create excess capacity during the 1970s. Inevitably
some countries or companies will not actively participate in
producer price schemes but will exploit them to full advantage.
These, rather than the active participants, gain the most. Over the
longer term there is a tendency to cheat and to discount in
periods of weak demand.
Aside from any tendency for over-rigid producer prices to
encourage excess capacity, there is a need to fund large stocks in
periods of weak demand. If producer prices are to be credible
compared with free market quotations, the latter must be
supported, however thin the market. In a severe recession almost
limitless funds and nerves of steel are needed to support a given
price. Unless the support level is carefully chosen, the available
funds will run out, market prices will plunge and the participants
will be faced with large book losses.
67
CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
That collusive action amongst suppliers to enforce list prices
is illegal in the major industrial economies by no means rules out
producer pricing. Some other countries lack effective anti-trust
rules, or may accept that the resultant price stability is beneficial
to their export earnings. The publication of list prices, even
without collusive action, is still common in the minor metals
and some industrial minerals. It often co-exists with a dealer
(or merchant) market in which prices are far more volatile. This
is not just because the latter quickly reflects changes in the
balance between the global supply and demand, but also because
merchants will gain access to varying proportions of the total
supply over the course of the business cycle. In good times
producers will control a much greater share of the total supply
than when conditions are depressed. Customers may have more
than they need and offload the excess onto merchants.
When merchant prices diverge from list prices in either
direction for extended periods, the producers’ list prices become
merely nominal and of little practical relevance. In time they may
be completely withdrawn and all pricing then becomes based on
the merchant market. Prices are usually indicated through regular
compilations in the technical press of the averages or ranges of
the quotations of individual merchants for specified grades and
volumes. No matter how assiduous and careful the compilers of
such prices, there is no guarantee that much trade actually takes
place at them. They are indicative at best. On occasion, market
participants have raised strong concerns about the validity of
some published prices.
For many market participants, price transparency is a mixed
blessing. There is often dispute about the relevance of published
prices to particular trades. Those purchasers who have managed
to obtain special deals and their suppliers, often prefer secrecy
rather than publicity. Prices are something agreed between
consenting adults in private, rather than blazoned over the pages
of the technical press. Traders also thrive where they can exploit
their unique knowledge of market conditions. Even so, the next
logical step from a large merchant-based market with opaque
price formation is the transfer of the process of price discovery to
some form of terminal market. That not only enhances
transparency, but offers opportunities for hedging price risk.
TERMINAL MARKETS
The essence of terminal markets is that prices are set at least on a
daily basis to balance that day’s marginal offerings and demand.
Directly or indirectly, those prices govern all that day’s
transactions, whether or not they are actually made through the
exchanges. The offerings and demand may come not only from
industrial companies, whether producers or users, but also from
merchants and investors of all types. Thus supply and demand in
these markets are much broader than production (whether of
primary or secondary material) and industrial usage.
Terminal markets may have four main interlocking functions,
which they fulfil in varying degrees. These are:
• the determination of daily reference prices for the products
traded;
• the provision of facilities for hedging against price risk;
• acting as a market of last resort through a dedicated
warehouse network; and
• giving opportunities for investment in metals as assets.
Each exchange has its different methods and traditions. The
leading terminal market for trading non-ferrous metals is the
London Metal Exchange (LME), which accounts for over 90
per cent of global exchange business for those metals it trades.
These are aluminium, aluminium alloy or secondary aluminium,
copper, lead, nickel, tin and zinc. The New York Mercantile
Exchange (Nymex) trades copper and aluminium through its
68
Comex Division, the Tokyo Commodity Exchange started an
aluminium contract in 1997, Kuala Lumpur trades tin and
Shanghai deals in several metals. New York, Tokyo, Hong Kong,
São Paulo and the London Bullion Market trade precious metals.
Crude oil and natural gas are quoted by Nymex and the
International Petroleum Exchange in London.
The London Metal Exchange
The London Metal Exchange was first established in 1877. It was
extensively re-organised in 1987 following the default of the
International Tin Council and the passage of the United
Kingdom’s Financial Services Act, and became a limited
company owned by its shareholders in 2001. Its activities are
closely related to the physical metals trade, but it had to be fitted
into the framework established under the Financial Services Act.
It is a Recognised Investment Exchange regulated directly by the
Financial Services Authority, which closely defines the
conditions under which the Exchange operates, and above all
requires that it maintains orderly markets in all its contracts. In
its activities in the US, such as the listing of approved
warehouses, the Exchange is governed by the relevant US
legislation and by the Commodities and Futures Trade
Commission (the CFTC). It is also subject to any relevant
Directives of the European Union. The Exchange is responsible
for maintaining and policing its trading rules and regulations.
A branch of the Financial Services Authority regulates the
commercial and ethical conduct of its members. Although the
Exchange is based in London, foreign companies ultimately own
most of its members and it is a truly global market.
A historical summary of LME contracts appears in Table 7.4.
The copper, lead and zinc contracts have a long history, as do
those for tin. Trading in the latter, however, was halted after the
collapse of the International Tin Council in October 1985 and
only resumed in 1989. The zinc contract was given new leases of
life by the final demise of European producer pricing in the
1980s and by the adoption of an LME pricing base by the US in
1993. Trading in aluminium started in 1978 and nickel followed
in 1979. Their respective industries initially shunned both
contracts and it was some years before they were fully accepted
TABLE 7.4
London Metal Exchange contracts.
Copper: 1877, with specification periodically changed. First official
LME contract 1883. Present Grade A contract June 1986.
Tin: 1877, with specifications periodically changed. Contract
suspended 25 October 1985 and re-introduced June 1989. First official
LME contract 1883.
Pig iron: 1877 until 1920s.
Lead: 1920, but traded unofficially before then. The specifications
have been periodically changed.
Zinc: 1920, but traded unofficially before then. The specifications have
been periodically changed. Present Special High Grade 99.995%
contract introduced June 1986.
Aluminium: December 1978, with the contract changed to High Grade
in August 1987.
Nickel: April 1979, with specifications periodically changed.
Silver: 1969 until mid 1989. New contract in May 1999 suspended in
March 2002.
Aluminium alloy: October 1992.
North American Special Aluminium Alloy Contract (NAASC):
March 2002.
Index: April 2000. Based on the six major metals.
Polypropylene and linear low density polyethylene: 27 May 2005.
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 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
as being representative. The contract for aluminium alloy began
trading in early 1992 and was also slow to gain acceptance. It
was joined by a North American aluminium alloy contract
(NASAAC) in March 2002. Pig iron was traded for a period until
the 1920s and trading in silver began in 1969, ceased in mid
1989, resumed on a new basis in May 1999 and was suspended
once more in March 2002. The relative importance of each
contract varies annually depending on the market conditions for
each metal. In 2003 aluminium accounted for almost 39 per cent
of the total number of lots traded, copper for nearly 28 per cent
and zinc for 15 per cent. Lead and nickel each provided around
six per cent of the lots traded, and the two aluminium alloy
contracts for roughly two per cent. Trading in two plastics
contracts started in May 2005.
Only a very small percentage of the volume of non-ferrous
metal produced and traded is physically delivered into LME
registered warehouses, but the bulk of the world’s non-ferrous
metals are traded by reference to LME prices, and the LME
captures by far the greater share of hedging business. Trading is
by open outcry across a ring, in which the dealers sit and shout
their bids or offers. This is backed up by a telephone-based
inter-dealer market outside ring trading sessions and by a screen
trading system, LME Select, which system was first introduced
in early 2001 and has been gradually refined. Like the telephone
market, it is only open to trading between LME member brokers.
The share of total LME business transacted through the Ring
itself has gradually declined to under two-fifths.
The basic contract for each metal is for three months forward,
with each working day being good for delivery against the
prompt, or delivery dates. Daily cash prices are also fixed, with
additional prices for 15 months ahead for lead and tin, going to
27 months for nickel, zinc and aluminium alloys and to
63 months for aluminium and copper. The period for those two
was extended from 27 months in September 2002. The prices are
strictly forward prices for future delivery on specified dates
rather than the futures prices traded in most other markets such
as Nymex. This is one of the LME’s distinguishing features. All
prices are fixed in US dollars, the prime currency of the
non-ferrous metals industry, but with facilities for also clearing
in sterling, Japanese yen and euros.
The prices established by open outcry at the close of the
second or official rings become the official settlement prices for
each day’s trading. These rings concentrate bids and offers from
the whole world into one brief and orgasmic trading session,
which reaches its climax at the closing bell. The prices reflect the
marginal tonnage offered and demanded that day, no matter the
source or the destination. They inevitably fluctuate daily, but
broadly reflect, under normal circumstances, the global markets’
balance of supply and demand.
Trade is conducted in lots rather than tonnes, with each lot of
aluminium, copper, lead and zinc amounting to 25 tonnes. Nickel
is traded in six tonne lots, tin in five tonnes and aluminium alloys
in 20 tonnes. Prices are set for metal that meets the prevailing
contract specifications, which are established with reference to
the needs of the producing and using industries. Individual
producers’ brands that meet the contract specifications can be
registered and are good for delivery once they have been tested
and accepted. The contract for each metal sets out the shapes,
weights and methods of strapping. The contract specifications
are not for the lowest common denominator of industry’s needs,
but for that quality and shape which is most widely traded and
demanded. Specifications have tended to rise over the years. In
the 1980s, for example, the aluminium specification was raised
from a minimum of 99.5 per cent aluminium to 99.7 per cent,
and the copper contract moved from wirebars to Grade A
cathode. The quality of zinc has been progressively raised,
initially from good ordinary brand to high grade, and then the
special high grade with minimum 99.995 per cent zinc that is
Australian Mineral Economics
traded today. The contracts specify minimum standards, which
many producers easily exceed. The daily prices do not
distinguish between the individual registered brands, but brokers
and traders may pay premiums for particular brands that are
especially in demand. Similarly, the price is for delivery into or
out of any registered warehouse, no matter where it is located,
and premiums may be established for specific locations.
Whether they are concluded on or off the ring, all LME
contracts are cleared through the London Clearing House.
Before the clearing arrangements were introduced in 1987,
brokers acted as principals, which meant that the market’s users
faced a risk of their broker defaulting. The clearing mechanism
offers security to all users of the market that their contracts will
be honoured, even if the initiating broker were to go bankrupt.
The prime distinguishing feature of LME contracts is that they
are not cash cleared. In other words, users of the market do not
have to contribute additional cash when their contracts are
making losses, nor can they take out profits ahead of the prompt
date; rather the contracts are cleared against bank guarantees,
with brokers granting credit to their clients. Most trade users also
do not insist that their business is segregated. These features
make the Exchange particularly useful for trade users, who do
not have to commit variable and uncertain amounts of working
capital to use the market.
Other exchanges that trade in metal futures or in energy
products, like the New York Mercantile Exchange, are cash
cleared. It was the ability to take out paper profits when prices
were rising that enabled the Hunt Brothers to drive up silver
prices so dramatically in 1979-80, when they were attempting to
corner the silver market. They could reinvest their paper profits
in margins on yet more futures contracts. When the bubble burst
and prices started falling, repeated calls for additional cash
margin accelerated and accentuated the decline of genuine
hedging as well as speculative business.
Credit clearing makes it easier for the metals industry to use
the market to hedge against price risks. Hedging is the
elimination of uncertainty at a known cost. Users of the market
with future commitments for purchase or delivery of physical
metal can buy or sell an equivalent and offsetting forward
contract that matures at the same time. The prices are known
today. When the time comes to deliver or buy, the user can close
out the forward contract and take either a loss or a profit to set
against the offsetting profit or loss on the physical contract. The
liquidity of each contract tends to diminish rapidly the further
forward they go beyond three months.
In addition to conventional forward contracts, the LME also
trades options. These give the purchaser or the seller the right, but
not the obligation, to buy or sell at the strike price. The premium
paid for this right varies inversely with the amount by which the
strike price varies from prevailing price levels. It is like an
insurance premium to protect against a known event. The LME’s
traded options are mainly so-called European options, which
refer to prices on specified future dates, the third Wednesday of
each month. Most users are much more interested in achieving
average prices over a period, such as a month or a year. Until 1997
the substantial and fast growing business in Asian options of this
type was conducted ‘over the counter’ (OTC) in deals specifically
tailored for the individual users. The LME introduced traded
average price options (TAPOs) in early 1997, initially for
aluminium and copper but now for all the metals, to provide the
protection of the clearing mechanism to such widely used
contracts, and to increase market transparency by bringing them
into the open. Most OTC options deals are denominated in US
cents per pound of metal, whereas LME contracts are expressed in
US dollars per tonne. The LME strike prices have, therefore, been
too coarse and inconvenient for it to attract as much business to its
contracts as it initially expected.
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CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

Metal brokers can provide an infinite variety of combinations of
forward prices and options to cover virtually any eventuality. The
underlying mathematics and the jargon of these price derivatives
can be complex, but their basic function is to enable producers and
users of metals to eliminate the risk of uncertain volatile prices at
a known cost. The use of options overcomes one of the basic
problems of forward contracts, which lock in specified prices. Use
of those denies the seller the benefit of any upside if prices at the
time of delivery greatly exceed the contract’s forward price, and
the purchaser the benefit of any fall below the forward price. The
latter is particularly important for fabricators who are actively
competing for business and operating on tight margins. One of
their major concerns is that their competitors do not buy their raw
materials on more favourable terms. No matter what combination
of hedging mechanisms is used, it is always the responsibility of
the user’s management to ensure that it is aware of exactly what is
being done and of the potential risks involved. The well-publicised
incidents in which companies have lost heavily in metals trading
have all been ultimately traceable back to lax management in the
affected companies.
The growth of options trading has been of especial value to
investors in metals, who are known pejoratively as speculators.
There always have to be individuals or firms who are prepared to
invest in metals in order to provide adequate liquidity to the
market. Without such liquidity, the costs of hedging could
become prohibitive. Moreover, prices could periodically swing
uncontrollably in one direction or another unless there were
always people who were willing and able to take contrary views
to the market as a whole. Trade use of the LME still accounts, on
average, for around 80 per cent of its total business, but the
Exchange’s turnover greatly exceeds the global production and
use of each metal. In 2003 the multiples of LME turnover to
global output varied from 17 for lead, up to 34 for copper, with
nickel at 22, aluminium at 26 and zinc at 28. The multiples were
much lower (three to six) for the aluminium alloy contracts.
These large multiples by no means reflect the amount of
speculative activity. A proportion of LME turnover comes from
brokers adjusting contract dates and volumes to meet the precise
needs of their customers.
We always have to be cautious in attributing sharp and
unexpected shifts in prices to the speculators. However good the
statistics about consumption and production in the recent past,
prices also reflect expected trends. We do not always have
sufficient knowledge about the present and the future. Forecasts
usually cluster together and they are often wrong, perhaps
because of random shocks. Sometimes market sentiment can
change dramatically, almost overnight, and prices have to catch
up. Sharp and apparently inexplicable price movements can often
be explained retrospectively by fundamental forces. Speculative
investment tends to even out over time and prices do broadly
reflect relative shifts in supply and demand. At times, however,
‘investment’ in metals as such can become substantial and prices
can then be driven up or down more than might seemingly be
warranted by underlying trends in supply and demand.
Much of the LME’s turnover arises from its use as a market of
last resort. LME contracts provide for physical delivery, and in
support there is a network of registered warehouses throughout
the world (see Figure 7.5). The Exchange itself does not own or
operate the warehouses nor does it own the metal they contain. It
approves warehouse locations, with the objective of having a
widespread network throughout the world in all important areas
of net consumption. Warehouse locations must have appropriate
fiscal and regulatory systems, be served by a good transport
network, have the facility to store goods without payment of duty
and enjoy political and economic stability. These requirements
rule out some apparently desirable locations. Once locations
have been decided, warehouse companies may apply to open
facilities. The contract between the Exchange and those
companies that satisfy its criteria sets out the warehouse
company’s rights and obligations and provides for a disciplinary
procedure. Metal of approved brands may be delivered into a
warehouse to satisfy delivery commitments in exchange for LME
warrants. These are bearer documents giving title to a specific
parcel of metal in a specified warehouse. The terms on which
metal is delivered and stored are agreed between the warehouse
companies and the companies who deliver it.

5 locations in the UK; all metals. 19 th century to 1994

12 locations, 6 countries in Europe: all metals 1962 to 1995

2 locations in Korea; not zinc 2001

7 locations in USA; all metals 1991 -98
4 locations in Japan; aluminium 1989

2 locations in Malaysia; all metals 2004

Singapore; all metals 1987

Dubai; not aluminium 1999 -2001

FIG 7.5 - LME registered warehouse locations in 2004. Note: the number of locations was increased during the 1990s to cope with an inflow of
metal associated with the collapse of the former Soviet Union and a global recession, and several little-used locations were recently de-listed.

70 Australian Mineral Economics

 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
When markets are over-supplied, metal flows into warehouses
and moves out again when markets tighten. Movements in the
stocks held in LME-registered warehouses are thus useful
bellwethers of market conditions. Over the years there has been a
progressive move towards placing a greater proportion of surplus
metal in LME warehouses. This partly reflects the growing use
of the Exchange for hedging and as a price reference and the
extension of the warehouse network. Warehouses were originally
confined to the UK, with locations first authorised in mainland
Europe during the 1960s. Singapore and Japan followed in the
late 1980s and the US in 1991. Dubai and Korea were added in
2001, although Dubai was good for silver delivery from 1999 to
2002, and Malaysia was being registered in 2004. Some locations
may not store particular metals, either because they are close to
major producing areas such as Singapore was historically with
tin (until the LME lifted this limitation in 2002), or because of
local restrictions on trade. Thus Japanese warehouses only store
aluminium, Dubai does not take aluminium and Korea may not
accept zinc. LME copper trading only commenced in the US in
1995.
The growth of LME stocks relative to total reported
inventories is also part of, and primarily mirrors, a global trend
towards reducing the amount of working capital tied up. If metal
is held in LME registered warehouses, there is much less need to
hold stocks in producers’ or consumers’ yards, and no need for
the metals industry itself to arrange their financing. LME
warehouses became magnets for surplus metal during the
recessions of the early 1990s. Excess western supplies were
greatly augmented by outflows from eastern countries. Although
much of the latter was not registered for LME delivery, it partly
displaced metal that was, allowing the latter to be delivered into
warehouses. Had the surplus metal not gone into LME
warehouses, most of it would have been absorbed elsewhere and
there would have been little, if any, cutback in production beyond
what actually occurred. From 1994 onwards the tonnage of metal
held in warehouses contracted, but the withdrawals did not
necessarily flow into final consumption. Much was taken out of
LME-registered facilities, partly to reduce its visibility and
influence prices. The expectation was that final demand would
soon rise sufficiently to absorb excess stocks. In actuality
demand rose less than expected and LME stocks levelled out.
The spread of the LME’s warehouse network from its
predominantly European focus changed LME prices from mainly
reflecting European balances between supply and demand into
global indicators. That in turn altered the structure of premiums
over and above LME prices for delivery in particular locations.
The LME’s settlement prices will inevitably reflect the balance
between deliveries of metal into warehouses and shipments out.
There may be net inflows in some locations at the same time as
metal is flowing out elsewhere. Not all locations and warehouses
are equally accessible or convenient and the charges for
removing metal vary. The warehouse companies in the less
favoured locations have sometimes offered inducements to
traders to place metal in their warehouses, and once it is there it
tends to stick.
The wider the warehouse network, the easier it becomes to
deliver metal onto warrant when markets are tight. When markets
are well supplied they are usually in contango. In other words,
prices for future delivery exceed cash prices by a margin that
represents the costs of storage and insurance and the rate of
interest, or the time value of money. To the extent that warehouse
companies offer any special deals on rents, the normal contango
will be reduced. Other things being equal, a rise in warehouse
rents or interest rates would be accompanied by a widening of
the contango. Often, however, such an adjustment would be
swamped by other influences on prices. The further forward the
quoted price, the greater the margin above cash prices, although
a lack of liquidity for the far forward dates could influence the
relationship. Without any extraneous shocks, the relationship
between prices for the different delivery dates is stable.
Australian Mineral Economics
When, for one reason or another, there is a shortage of metal
for immediate delivery, prices move into a backwardation. That
means that cash prices for immediate delivery rise above the
forward prices. There may be sound fundamental reasons for a
backwardation, like a prolonged shortage of supply relative to
buoyant demand, perhaps caused by transport disruptions or a
strike at a major producer. The only cure is an influx of metal
into LME warehouses that is sufficient to restore balance. A
backwardation often makes it worthwhile for those who have
excess tonnage, however temporarily, to deliver into warehouses
in order to earn a rate of return that may greatly exceed the cost
of finance. The emergence of bubbles in the pattern of prices is,
however, often a sign that someone is attempting to squeeze the
market. In other words, they may have gained control of the
greater part of the available LME inventory and also have large
long positions which give them potential access to far more
metal than they need to meet their future commitments. Those
who are short will have to pay the backwardation or borrow
metal at a cost in order to meet their commitments. Occasionally
a merchant may inadvertently ‘squeeze’ the market, but more
usually there will be deliberate manipulation, which offends
against the preservation of orderly markets, one of the LME’s
prime functions as a Recognised Investment Exchange.
Backwardations raise the costs of hedging for physical users of
the market, sometimes prohibitively. They can also distort the
validity of LME quotations as reference prices for the global
metals industry. The LME’s Rules and Regulations give it
considerable powers to prevent manipulation and punish any
members who break those rules. Unfortunately, although it is
relatively easy for market participants to suspect when a price is
being manipulated, proof is usually difficult. Also, the Exchange
has no jurisdiction over either the parallel physical market or
non-LME business. Squeezes may often be engineered in the
over-the-counter market rather than in LME contracts, although
they find their full flowering in the behaviour of LME
quotations. The best defence against market manipulation is the
greatest possible transparency in all types of trade. Since
mid-1996 the LME has greatly increased the amount of
information that it publishes, but it always faces a difficult
balancing act. An excessive insistence on transparency could
lead to trade drying up or being driven offshore, or to
over-the-counter markets that are outside the scope of any
regulation. That would not necessarily be in the users’ best long-
term interests.
The LME’s main competitor, the New York Mercantile
Exchange, has claimed that it has lost trade to the LME because
the latter has been less tightly regulated. Close inspection
indicates that the methods of regulation in London and New York
are certainly very different, but that the LME is no less tightly
controlled and policed than its US counterpart. The main reason
that the LME captured most of the global business in non-ferrous
metals is that its contracts and methods of trading have been
more suited to the needs of trade users than those operated in
New York. The LME’s main attractions include its system of
prompt dates, its extensive warehouse network and its credit
rather than cash clearing. It also straddles the three main global
time zones, picking up the close of business in Asian markets
early in the day and overlapping with New York in the afternoon.
Finally, the UK does not have a large domestic mining and
smelting industry with vested interests, but it has a long tradition
of open markets and liberal trading. The Comex Division of the
New York Mercantile Exchange has much lower liquidity, with
trade concentrated on hedging by domestic US companies and on
speculative investment business. A considerable amount of its
trading is conducted on their own account by ‘locals’, rather than
for trade clients. Arbitrage between the London and New York
markets has ensured that their respective prices rarely step too far
out of line with each other.
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CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR
The present systems will only survive, however, as long as the
markets’ users are content that they give prices that are properly
representative of market conditions. The prices set are far more
chaotic and seemingly more haphazard than producer pricing
systems, but more transparent and reflective of changing market
conditions.
Some criticise LME prices as being excessively volatile, under
the influence of investment in metals by financial institutions of
all types, often grouped under the general description of
‘speculators’. Certainly, prices can move markedly even within
the course of a day, let alone from one day to the next. The
explosive growth of options-related business also appears to have
introduced extra volatility. Much of that business, however, is
conducted on the behalf of producers and fabricators insuring
against adverse future price trends. To the extent that a
significant proportion of annual production is protected for
months (or even years) ahead, that much will be less responsive
than it might previously have been to weakening prices. The
protected producers will have no immediate need to cut their
output because they are incurring cash losses. That in turn means
that the burden of any excess supplies in recessions is thrown
more heavily than in the past on prices rather than volumes. That
alone will give the appearance of increased price volatility, but it
owes nothing to speculative activity. Any genuine evidence that
prices of non-ferrous metals have become more volatile in recent
years because of speculative activity is rather tenuous. Those
who assert that prices have become more volatile have usually
looked at trends over relatively short periods and have failed to
allow fully for the many factors influencing prices.
RECENT TRENDS IN MINERAL MARKETS
At the start of the new millennium most sectors of the minerals
industry seemed set for a prosperous decade. The major
international political tensions that had persisted since the
Second World War were largely resolved, market capitalism had
seemingly triumphed over more dirigiste systems and the global
economy was becoming increasingly unified. It had quickly
shrugged off the Asian crises of 1997-98 and had resumed
apparently healthy expansion, inflation had been tamed, currency
markets were relatively stable and oil prices remained subdued.
Subsequent events showed that any complacency was sadly
misplaced and that turbulence was developing beneath an
apparently smooth surface. Led by the US, the major industrial
economies were on the brink of recession and new political
tensions and uncertainties were developing in the world at large.
Demand for mineral products is driven by economic activity,
which faltered in 2001 after a strong start to the decade.
Figure 7.6 shows the annual rates of change of output, both
globally and in the major advanced economies (Canada, USA,
Japan, France, Germany, Italy and the UK) from 1998 onwards.
6 -4
World
5 Major advanced economies
% per annum change
3
2
1 had not recovered from the ravages of war and some members of
0 US, raised their consumption in 2003 and 2004 after several
1998 1999 2000 2001 2002 2003 2004
FIG 7.6 - The growth of economic activity (gross domestic product),
1998-2005. (Source: International Monetary Fund, 2005.)
72
From 1999 onwards global growth was much greater than that of
the advanced economies, but the world economy was knocked by
the latter’s recession in 2001-02. The upswing in 2003-04 was
unexpectedly strong, with overall activity rising rapidly in 2004.
Growth continued in 2005 at a slower rate (International
Monetary Fund, 2005). The strength of global activity over the
period owed much to the strength of the Asian economies,
especially of China. The buoyant Chinese economy has been one
of the main forces driving demand for mineral products over the
past decade. Its share of world output (measured on a purchasing
power parity basis) rose from 10.2 per cent in 1988 to 13.2 per
cent in 2004. This has been partly at the expense of growth
elsewhere, with Chinese exporters benefiting from a low cost base
and an undervalued currency, but it mainly reflects strongly
growing internal demand, led by heavy investment in plant,
equipment and infrastructure.
The relationship between overall economic activity and the
mineral and metals industry is brought out in Figure 7.7, which
compares annual percentage changes in global GDP, the usage of
refined copper and the output of crude steel. Although demand
for each mineral and metal product is driven by different end-use
markets, all follow broadly similar trends. Many depend directly
on the performance of the steel industry. Copper usage grew
particularly strongly in 1999-2000 when the US economy was
booming, but it fell in 2001 and grew more slowly than global
activity in 2002-03. By contrast steel production was relatively
weak in 1998-99, but has grown much more strongly than global
GDP since 2001. Its strength derives from China’s burgeoning
output, which increased by 23 per cent in 2004 alone. China’s
production of crude steel rose from 115 Mt in 1998, under 15 per
cent of the total, to 272 Mt (26 per cent of global production) in
2004. It accounted for 57 per cent of the growth in global steel
output over the six year period. Inevitably this rapid growth has
spilled over into strongly increased demand for raw materials
from overseas and in that regard steel has been typical of most
minerals, including fuels.
10
World GDP Refined copper usage Crude steel output
% change on previous year
8
6
4
2
0
1998 1999 2000 2001 2002 2003 2004
-2
FIG 7.7 - Global GDP, copper usage and steel output, percentage
per annum changes 1998-2004. (Sources: International Monetary
Fund, 2005; International Copper Study Group, 2005; International
Iron and Steel Institute, 2005.)
A strong global economy not only boosted demand for
non-fuel minerals, but also for fuels including petroleum. World
demand for crude oil, shown in Table 7.5, rose by 3.4 per cent in
2004 (the largest percentage increase for many years) forcing
demand against the constraints of effective capacity. Iraq’s output
OPEC held back production. The OECD countries, led by the
2005 years of stagnation. The US accounts for 25 per cent of global
off-take, OECD Europe for 19 per cent and Japan for seven per
cent. China (eight per cent) and India (three per cent) were major
contributors to the 6.7 per cent rise in non-OECD demand.
Australian Mineral Economics
 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

130

TABLE 7.5
World oil demand (million barrels per day).

Index numbers. January 1998=100

120
(Source: International Monetary Fund, 2005.) Major currencies

Year World OECD Non-OECD

110
1998 74.7 46.6 28
1999 76.1 47.4 28.8 US trading partners
100
2000 76.9 47.6 29.3
2001 77.4 47.5 29.9
90
2002 78.2 47.6 30.6
2003 79.6 48.1 31.5
80
2004 82.3 48.8 33.6 1998 1999 2000 2001 2002 2003 2004 2005

The effects of this strong growth of demand on prices were
accentuated by existing political tensions in the Middle East and
by fears that unrest is spreading to major producers like Saudi
Arabia. Speculative pressures were further influences in driving
crude oil prices up to their highest levels in real terms since the
1970s. In money terms, prices have never been higher. Their
behaviour from 1999 onwards, as expressed in the spot price of
Brent crude on the International Petroleum Exchange in London,
is illustrated in Figure 7.8.
60
50
40
US $/barrel
FIG 7.9 - Effective monthly average real exchange rates of the
US dollar. (Source: US Federal Reserve Board, 2005.)
Prices of most minerals and metals are denominated in US
dollars and the US exchange rate is a strong influence on those
prices. Other things being equal, a strengthening of the US dollar
leads to falling dollar prices, and a weakening dollar to rising
dollar prices. Many producers whose currencies strengthened
against the dollar also saw rising costs and falling margins in
2000-02 to the point where they were forced to suspend or curtail
operations. The adverse impact of the currency squeeze was
accentuated by the simultaneous weakening of demand because
of recession. Capital spending of all types, but especially on
exploration and grassroots projects, was pared back as the
industry strove to minimise costs. These years witnessed a surge
in mergers and consolidations in many sectors of the industry,
with a pronounced peak in 2001 (Raw Materials Group, 2004).

30
20
10
0
1999 2000 2001 2002 2003 2004
FIG 7.8 - Monthly average prices of crude oil (US$/barrel for
Brent crude). (Source: International Petroleum Exchange, 2005.)
Prices had weakened in 2001-02 in response to recession, with
the attack on the World Trade Centre in September 2001 having
no real impact. The Iraq war caused a minor blip in 2003, but
prices really only started to rise strongly during 2004. Whereas
prices around the $30/barrel level had been regarded as
acceptable, their rise to over $50/barrel has raised concerns about
possible adverse effects on global inflation and levels of
economic activity. Forecasts of economic growth were
consequently being shaved down in early 2005. Not only do high
oil prices have potentially adverse effects on demand for mineral
products but they also directly raise production costs.
In part, the rise in oil prices was initially justified by an
accompanying weakening of the US dollar in currency markets.
Some oil producing countries tailored their supply in order to
raise prices sufficiently to offset the dollar’s decline, but such
fine-tuning is seldom possible. The performance of the US dollar
has been a major influence on the prices of all internationally
traded mineral commodities. Figure 7.9 plots two measures of
the real effective exchange rate since January 1998. It
strengthened by 21 per cent against a weighted average basket of
major currencies (those of Australia, Canada, ‘Euroland’, Japan,
Sweden, Switzerland and the UK) between October 1999 and
February 2002. It followed a similar trend, but to a less marked
extent against the currencies of a much larger group of its trading
partners, partly because some of those currencies are pegged to
the dollar itself.
The gold industry was especially hard hit by weak prices in the
late 1990s and early 2000s. Exploration spending of all types, but
especially on gold, had peaked in 1997, and it subsequently
plummeted, not just in response to weak markets, but also
because of the adverse effects of the Bre-X fraud (where a gold
project in Indonesia had been hyped on the basis of non-existent
ore reserves) and the competing lure for speculative investors of
dot com projects. The trough in exploration spending was
2005
reached in 2002, with that on gold down from 1997’s US$ 2.6
billion to under US$ 0.8 billion. Exploration for other products
dropped from US$ 2.5 billion to US$ 1.1 billion over the same
period. The recovery in prices from their recessionary trough
brought a corresponding revival of exploration, with spending on
gold rising to US$ 1.9 billion in 2004, and that on other products
up to US$ 3.8 billion (Metals Economics Group, 2005).
The inverse relationship between real US dollar exchange rates
and gold prices is illustrated in Figure 7.10. Gold prices averaged
below US$ 400 per ounce throughout the 1990s and had fallen
sharply from 1996. The recovery began in late 2001, after the
attacks on the World Trade Center, and it was fostered not just by
the weakening US dollar, but also by rising international
tensions. Rising oil prices and fears of resurgent inflation gave an
added boost from late 2004.
Prices of non-ferrous metals lagged behind gold prices in
2002-03. In some cases capacity had outstripped demand,
notwithstanding mine and plant closures and cutbacks. There
were also large inventory overhangs, particularly in the most
visible form of Exchange stocks. Their existence initially
moderated the impact of improving supply/demand balances on
price levels. Table 7.6 shows the end-year levels of LME
warehouse inventories from 1998 onwards.
LME warehouses are not the only sources of readily available
metal and stocks have moved substantially within each year.
Nonetheless, Table 7.6 gives a broad indication of the changing
pressures of demand for the various metals. They all danced to
the beat of economic activity, but with different timings and
variations. Speculative activity by financial institutions of all
types, including hedge funds, may have hastened (and even
enhanced) some price rises, but the basic determinants were

Australian Mineral Economics 73

 CHAPTER 7: MINERAL MARKETS, PRICES AND THE RECENT PERFORMANCE OF THE MINERALS AND ENERGY SECTOR

160
Until recent years, demand grew relatively slowly and producers
150
were fairly reluctant to invest in capacity in anticipation of future
Gold price sales. In consequence the 2003-04 spurt in demand created
Index numbers January 1998=100

140 supply bottlenecks and suppliers seized their advantage with

sharp price rises. Mine expansions and new capacity are under
130 construction that will improve the market balance within a few
years, but markets will remain tight in the interim. Contractual
120
US dollar prices of internationally traded thermal coal rose by
110
nearly 70 per cent in 2004, whilst those of coking coal rose by
about 26 per cent in 2004 and by roughly 116 per cent for 2005
100 deliveries. Prices of iron ore also jumped for 2005 deliveries, but
by a more modest 71.5 per cent. Even allowing for the
90
weakening of the US dollar, producers are earning handsome
80
profits at these prices and potential new entrants are jostling for
35796 35977 36161 36342 36526 36708 36892 37073 37257 37438 37622 37803 37987 38169 38353 position. Figure 7.12 compares yearly index numbers of prices of
iron ore and of base metals. Iron ore had lagged until the 2005
FIG 7.10 - Index numbers of monthly average gold prices and real price settlements.
effective exchange rates of the US dollar against major currencies. 260
(Source: US Federal Reserve Board, 2005; London Bullion Market
240 Iron ore
Association, 2005.) (Hamersley fines to Japan f.o.b.)
220

Index numbers 1999=100

200
TABLE 7.6
Inventories in LME warehouses at year-end, 1998-2004 180

(thousands of tonnes). (Source: London Metal Exchange, 2005.) 160

Year Aluminium Copper Lead Nickel Tin Zinc 140

1998 635 592 108 66 8 317 120

1999 774 790 176 47 9 279 100

Non-ferrous metals
2000 322 357 131 10 13 195 80 (The Economist index)
2001 821 799 98 19 31 433 60
1999 2000 2001 2002 2003 2004 2005
2002 1241 856 184 22 26 651
FIG 7.12 - Index numbers of prices of iron ore and non-ferrous
2003 1423 460 109 24 14 740
metals, re-based on 1999 = 100. (Sources: The Economist, 2005;
2004 695 49 40 21 8 629 Metal Bulletin, 2005; Mining Journal, 2005.)

improving demand and a weakening US dollar. Figure 7.11 Many commentators in late 2004 and early 2005 were
shows the behaviour of a weighted average index of non-ferrous heralding a lengthy period of strong prosperity for the metals and
metal prices from the start of 1999. Prices rose during 1999, but minerals industry. Few had properly observed the lessons of
levelled out in 2000 and fell back between September 2000 and history that barriers to entry are fairly low and that demand is
late 2001. The recovery did not really get into its proper stride dependent not just on the performance of a single country
until after May 2003. (however bright its prospects might seem) but on a complex
That the rise in prices sprang from much more than speculative interplay of global forces. Profitability depends on the ratio
activity in a terminal market was shown by the simultaneous between prices and costs and many of the factors that lowered
improvement of the prices of many minor metals, of industrial costs in the preceding decade or so have worked themselves out,
minerals and of bulk minerals, including coal and iron ore. The or have even reversed.
latter two have greatly benefited from China’s burgeoning
demand, but their latest price increases should be judged against REFERENCES
their lacklustre performance for much of the preceding decade.
British Petroleum, 2004. BP statistical review of world energy [online].
Whereas the non-ferrous metals are priced on terminal markets, Available from: <http://www.bp.com>.
which provide both opportunities for hedging price risk and a
International Copper Study Group, 2005. [Online] <http://www.icsg.org>.
market of last resort, producers of bulk minerals have neither.
International Iron and Steel Institute, 2005. [Online]
160
<http://www.worldsteel.org>.
International Monetary Fund, 2005. World economic outlook database,
150 April [online]. Available from: <http://www.imf.org>.
140 International Petroleum Exchange, 2005. [Online] <http://www.ipe.com>
Index numbers 2000=100

now listed under Intercontinental Exchange: <http://www.theice.com>.

130 London Bullion Market Association, 2005. [Online]
120 <http://www.lbma.org.uk>.
London Metal Exchange, 2005. [Online] <http://www.lme.co.uk>.
110
Metal Bulletin, 2005. [Online] <http://www.metalbulletin.com>.
100 Metals Economics Group, 2005. [Online]
<http://www.metalseconomics.com>.
90
Mining Journal, 2005. [Online] <http://www.mining-journal.com>.
80 Raw Materials Group, 2004. Database, May, Stockholm, Sweden.
70 Smith, A, 1976 [1776]. An Enquiry into the Nature and Causes of the
Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Wealth of Nations (eds: R H Campbell, A S Skinner and W B Todd)
(Oxford University Press: Oxford).
FIG 7.11 - The Economist index of non-ferrous metal prices. The Economist, 2005. [Online] <http://www.economist.com>.
Monthly averages, 2000 = 100. (Source: The Economist, 2005.) US Federal Reserve Board, 2005. [Online] <http://www.federalreserve.gov>.

74 Australian Mineral Economics

 CHAPTER 8

The Mineral Sector Workforce

Philip Maxwell

A Global Perspective
Mineral Sector Employment in Australia
Important Mineral Sector Workforce Issues
Summary and Conclusion

A GLOBAL PERSPECTIVE
In those developed nations with strong non-renewable resource More
sectors, mining operations are capital and technology intensive. Capital
(and technology) Major Large mines
While only employing small numbers, these operations require intensive mineral in developed
highly professional workforces. The wages and salaries of such exporters nations
personnel are high. The combination of professional workforces,
large capital investment and modern technology has ensured that Factor Large mines
intensity in
countries such as Canada and Australia have maintained their developing
international mineral sector competitiveness in the last half of the in mines
nations
Large mines in
20th century and into the new millennium. transition
Recall the nature of the economist’s production function: economies

Artisanal and
Output = f (land, labour, capital, environment) More small-scale mining
labour
intensive

Capital, land (mineral endowment) and technology are More

relatively more important factors than labour, though the
personnel employed need to be well-trained and professional.
The situation is often different in developing nations that have
strong mineral economies. In the ‘formal’ mining sector, lower
wage structures typically mean that workforces are larger and
that managers can use more unskilled labour. Capital intensity is
not so high. Hence, a large mine may employ a workforce of 400
people in countries like Australia or Canada, but a mine
producing a similar level of output in Indonesia, Papua New
Guinea or Tanzania, might employ, say, 2000 people. There are
some developing nations (such as Chile and Peru) that have work
forces more typical of the developed countries than those like
PNG or Indonesia.
It is also important to mention mining employment in those
economies in transition between socialism and capitalism, most
of which now meet our definition of developing nations. In the
resource-rich nations of the former Soviet Union and Eastern
Europe, and in countries such as China, Vietnam and Mongolia,
mines typically employ relatively large workforces. This is a
legacy of a previous system that ensured full employment for the
populace, even though wage levels were low.
As will be seen, artisanal and small-scale mining is also
important in many developing nations. This is labour-intensive
mining with little use of sophisticated physical capital or
technology.
Less
developed developed
Stage of national development
FIG 8.1 - Relative capital and labour intensity in operating mines.
A conceptual view of mineral sector employment and its
relationship to the capital (and technical) intensity in mines
appears in Figure 8.1. The upward arrows reflect recent and
continuing trends towards greater substitution of capital and
technology for labour.
The formal mining sector
While the International Labour Organisation (ILO) collects
employment data for most nations in a systematic way, there are
presently no comprehensive official estimates of the size of the
world’s mining sector workforce. The indicative data for the year
2001 shown in Table 8.1 come from the ILO and the work of
Hilson (2002). They cover Europe, North and South America and
Australia in a reasonably comprehensive way but there are
notable gaps for Africa and for many Asian nations. The estimate
of just over one million people for employment in large and
medium mines in these other nations may be low. Recognising
these limitations, our estimates suggest that there were more than
19 million people employed in mining in 2001.

Australian Mineral Economics 75

CHAPTER 8: THE MINERAL SECTOR WORKFORCE

mining sector to be much higher. Employment in the iron ore

TABLE 8.1
industry makes an important contribution to the total.
An indicative estimate of the world’s mining workforce in
2001, including metals, non-metals and energy minerals. At first glance, it seems surprising that Canada’s mineral
(Source: International Labour Organization, 2004; Hilson, 2002.) sector employment of more than 170 000 in 2001 is more than
twice that of Australia’s. As in the US, well over half of this is
The formal mining sector based in the oil and gas sector, while only around 46 000
European nations ’000 Major exporters ’000 represent employment in coal, uranium and the non-fuel minerals
Bulgaria 37 Australia 75
sectors.
Among the developing nations, China stands out dramatically
Czech Republic 67 Brazil 118
with its formal mining sector workforce of almost 2.5 million
France 41 Canada 174 people. From the available data, nations such as India, Mexico,
Germany 138 Chile 72 Colombia, Saudi Arabia and Kazakhstan also have significant
resource sector workforces. As better information becomes
Greece 16 South Africa 405
available it will be possible to add many other nations to the list
Italy 56 Peru 47 in Table 8.1.
Norway 13 Table 3.3 showed that the estimated population of the 33
Poland 273 Other Americas developed nations in our classification (those with HDI values of
0.850 and above in 2001) was 935 million people. This was 15.3
Russia (estimate) 1000 United States 606 per cent of the world’s population of just over 6.1 billion. They
Romania 149 Mexico 127 produced more than half the value of the world’s minerals and
Serbia and Montenegro 42 Colombia 191 energy output. Although the major mineral producers – the
United States, Canada and Australia – number among this list,
Slovakia 22 Venezuela 50 the developed nations accounted for an estimated 1.46 million of
Spain 61 Ecuador 42 the world’s 18 million minerals and energy sector workers, only
Sweden 7 eight per cent of the total. Mine workers in these nations were
located in the top two blocks (ovals) in Figure 8.1.
Turkey 89 China 2440
Ukraine 637 India 550 Artisanal and small-scale mining
United Kingdom 73
Artisanal and small-scale mining has historically been the most
Other Europe (estimate) 79 Saudi Arabia 326 traditional form – for example, the gold rushes in Australia were
Kazakhstan 166 largely driven by small-scale mining, which gave way to more
Total Europe 2800 capital intensive and larger mining operations when easily
obtainable deposits became less available. Even today in
Other formal (estimate) 1011
Australia, individuals or small groups still hold small tenements
Total formal 9200 as they search for a bonanza that will solve all their financial
Small-scale and artisanal 10 000 woes. Similar stories apply in many other nations.
Total minerals and energy 19 200 In many developing nations with considerable mineral
endowments, artisanal and small-scale mining has a more
significant economic and social role. As Hilson (2002) notes, it
In Europe, for example, most mining and/or oil and gas provides employment to many people in remote regions where
extraction is for domestic consumption. The minerals sector in few other opportunities exist, and it also contributes positively to
the 19 developed nations of Western Europe employed around foreign exchange earnings and mineral export bases.
550 000 people in 2001, yet economies such as Ukraine, Poland Unlike the formal mining sector in which larger companies
and Romania and Russia that were previously part of the Soviet participate, artisanal and small-scale mining often exists outside
bloc still have significant mining workforces – more than two any public sector regulatory framework. Such unregulated
million people were employed in the minerals and energy sector operations typically cause considerable damage to the physical
in these transition economies. Hence the European resources environment, while workers are exposed to unsafe and unhealthy
sector alone employed an estimated 2.8 million people at the turn working surroundings. Such mining can also lead to cultural
of the new millennium. conflicts where outsiders invade the traditional lands of
The United States has been a leading mineral producer for indigenous communities.
much of the last 150 years. With exceptions in industries such as As developing nations have opened up to foreign investment in
gold, copper and some coal, most production now focuses on the mineral sector since the late 1980s, small-scale and artisanal
domestic needs. The large majority of the value of US production miners have come more into conflict with the formal mining
is in oil and gas, but of the estimated 591 000 workers in the sector. It is now quite common for large mines in the formal
sector in 2004, only 66 000 worked in the oil and gas sector, sector to exist side-by-side with traditional artisanal miners. This
while 87 000 were in coal mining, 107 000 in non-metallic is happening more often in Africa and nations such as Indonesia
mining and quarrying and 75 000 in metal mining. and Papua New Guinea.
Among the major mineral exporting nations, Australia’s Estimates of the importance of the level of employment in
mineral sector employment is small in comparison with those in small-scale mining vary. At the high end, the World Bank
South Africa, Brazil and Canada. The higher employment in website (World Bank, 2004) states that:
South Africa is a reflection of its status as a developing nation,
with the substitution of labour for capital. Yet, in the aftermath Today, an estimated 13 million people in about
of the apartheid regime, mining employment has fallen 30 countries across the world are small-scale/
consistently. Given Brazil’s developing country status, large land artisanal miners, with about 80 million to 100
area, and major population base of 170 million people (in 2001) million people depending on such mining for
one might intuitively expect employment in its large-scale their livelihood.
Hilson (2002) has provided some more detailed estimates for
1. Where Hilson provides a range in his estimates, the mid-point has 25 selected nations. The data in Table 8.2 are derived from his
been selected. figures1. His list excludes several African nations in which

76 Australian Mineral Economics

 CHAPTER 8: THE MINERAL SECTOR WORKFORCE

TABLE 8.2 Gold checked and for a time reversed Australia’s

Estimates of employment in small-scale and artisanal mining in tendency to become a land that favoured the big
2001. (Source: Derived from Hilson, 2002). man. Whereas Australia’s first natural asset, the
Country Estimated Country Estimated sheeplands, was grasped by a few thousand men,
employment employment its second rich natural asset, the goldlands, was
(’000) (’000) divided among hundreds of thousands of men.
Argentina 6 Mali 200 During the gold rushes, mining employed appropriately 20 per
Bolivia 70 Mexico 30 cent of Australia’s workforce. The exhaustion of alluvial gold
meant that more capital-intensive large-scale mining replaced
Brazil 1000 Mozambique 60 labour-intensive small-scale mining. In the wake of the Western
Burkina Faso 60 Pakistan 230 Australian gold rushes, mineral sector employment still stood at
China 4000 Papua New Guinea 55 eight per cent of total employment in 1901, but as Figure 8.2
shows, there was a dramatic decline in mining employment as a
Colombia 150 Peru 20
percentage of total employment during and after the First World
Ghana 200 Philippines 200 War. This downward trend has continued ever since. Even the
Ecuador 92 South Africa 18 Resources Boom in the 1960s did not reverse it. By the turn of
the new millennium, the sector accounted for approximately 0.8
Guyana 15 Tanzania 525
per cent of total employment – a tenth of its percentage level a
Haiti 5 Vietnam 38 hundred years earlier.
India 500 Zambia 30 The Australian Bureau of Statistics (ABS) publishes detailed
Indonesia 465 Zimbabwe 200 information about the minerals and energy sector in its annual
survey, Mining Operations Australia. It also provides useful
Malawi 40 Other (estimate) 1800 small area data on mining employment at the five yearly national
Total 10 000 census. The following discussion draws from the 2001 Census
and from Mining Operations Australia 2000-01.
artisanal and small-scale mining takes place. Among them are
Angola, Cameroon, Democratic Republic of Congo, Guinea, 8
Per
Niger, Nigeria and Togo. Also excluded are several Asian nations cent
and the majority of countries in the former Soviet bloc. The 7
numbers in the modified Hilson list add up to a little more than
seven million people. If one allows for some of the additional 6
nations, our view is that the numbers are likely to be closer to
nine million people2.
5
Interaction between artisanal and small-scale miners and
foreign mining companies in developing nations has become
4
much more common in the past 15 years. There is potential for
misunderstanding and conflict between each group. Balancing
the interface between small and large mining interests, as well as 3
regulating small-scale mining in an appropriate way, are major
policy challenges in mineral-rich developing nations. 2

MINERAL SECTOR EMPLOYMENT IN AUSTRALIA 1

Historical trends
As has been seen in the preceding section, the resources sector in
Australia now employs a relatively small workforce. This has not
always been the case. In discussing the gold rushes of the 1850s,
Blainey (2003, p 62) comments that:
2. While somewhat lower than the World Bank estimate, the difference
may be due to us estimating more people in the formal mining sector
than they have done.
3. These were the latest data available as this chapter was written.
4. This seems an underestimate because, in the words of this publication
(ABS, 2002a, p 28):
Many of these contractors are classified to industry
categories such as construction and transport that are out
of the scope of the mining collection.
The publication acknowledges a higher estimate of 16 069 full-time
equivalent contractors by the Minerals Council of Australia. This
would place the total workforce employed in Australian mineral
ventures at close to 70 000 in 2000-01. This compares with the
estimate of 75 100 reported in the 2001 national census. The latter
figure may have been inflated by a small but significant group of
Australian residents who fly in and out of mines in other nations (eg
Indonesia, Papua New Guinea and several African nations).
0
1900 1920 1940 1960 1980 2000
FIG 8.2 - Mineral sector employment as a percentage of total
employment, Australia, 1900 - 2001.
Employment, value added and capital intensity
In Mining Operations Australia, the ABS reports employment data
by management unit and not by establishment. Management
units are companies (which often operate more than one mine)
and joint ventures. In 2000-01, the ABS estimated that there were
66 677 people employed in 1340 management establishments3.
This included 13 823 ‘contractors’ who provided services to
mining4.
As can be seen from Table 8.3, these workers contributed
almost $34 billion to Gross Domestic Product (about 4.7 per cent
of the total). The average value added per employee was
$509 000. There was wide variation between sectors, with the
average worker in oil and gas responsible for adding over
$2.5 million. This was more than three times the next highest
sector (iron ore) where value-added per employee was $710 000.
The figure in the coal industry was $326 000 and in gold only
$226 000. The histogram in Figure 8.3 highlights the wide
differences between sectors.

Australian Mineral Economics 77

CHAPTER 8: THE MINERAL SECTOR WORKFORCE

TABLE 8.3
Value added and total assets per employee in the Australian mineral industry 2000-01. (Source: Australian Bureau of Statistics, 2002a.)

Industry sector Employment Value added Value added per Total assets Total assets per
($ M) employee ($ M) employee
($’000) ($ M)
Coal mining 17 256 5625 326 17 780 1.03
Oil and gas extraction 6714 16 907 2518 41 041 6.11
Iron ore mining 4525 3211 710 7355 1.63
Copper ore mining 3864 1526 395 6225 1.61
Gold ore mining 8096 1833 226 8903 1.10
Mineral sands mining 1679 600 357 1632 0.97
Silver/lead/zinc 2265 912 403 4079 1.80
Other metal mining 2628 1518 578 6357 2.42
Other mining 5827 891 153 3074 0.53
Services to mining 13 823 934 68 5577 0.40
Total 66 677 33 958 509 102 023 1.53

2600

2400

2200

2000

1800

1600
(A$,000)

1400

1200

1000

800

600

400

200

0
Coal Oil and Iron ore Copper Gold Mineral Silver- Other Other Services
gas sands lead-zinc metal mining to mining

FIG 8.3 - Value added per employee in key mineral sectors – Australia 2000-01.

The final columns of Table 8.3 provide another reflection of
the capital-intensive nature of the industry. Oil and gas again
stand out, with average total assets per employee at more than
$6 million. The next group was ‘Other metal mining’, which
included most nickel mines. It had less than half the amount
of assets at $2.42 million per employee. Silver/lead/zinc
($1.8 million), iron ore ($1.63 million) and copper ($1.61 million)
were next, while gold trailed with $1.1 million.
Salaries, wages and employment levels
As the estimates in Table 8.4 and Figure 8.4 reveal, mineral
sector employees are the best paid among the major industry
groups in Australia. While the ABS estimated that average
annual incomes of Australian workers stood at $33 500 in
November 2000, the average mining income was estimated at
$78 400 – more than double. There was wide variation across the
sectors, with oil and gas at the top with average wages more than
$105 000 and mineral sands ($45 861) and other mining
($50 798) at the bottom. One of the main segments of the ‘Other
mining’ group are workers in the mines and quarries near to
major cities, who extract and process industrial minerals. As well
as oil and gas, workers in the coal, iron ore, silver/lead/zinc and
other metal mining (which includes nickel) areas had incomes
above the mining average. These high wages reflect payment for:
• working in harsh environments;
• living in, or commuting to, remote locations; and
• recognition of specialist training and responsibility in
operating expensive capital equipment.
In combination with these factors, volatile mineral prices and
wide swings in the mining business cycle have ensured that there
tend to be greater movements of labour in and out of the minerals
sector. This has particularly influenced the exploration sector and
the fortunes of geologists. The high level of wages and salaries also
reflect these movements, which has led at times to skilled mining
professionals and other personnel being able to derive ‘quasi rents’
because they are in short supply for specific time periods.

78 Australian Mineral Economics

 CHAPTER 8: THE MINERAL SECTOR WORKFORCE

TABLE 8.4
Average employment levels and salaries in Australian mineral industry – 2000-01 financial year. (Source: ABS, 2002a.)

Industry sector No of units Employment Employment per unit Wages and salaries Average wages (A$)
(A$ M)
Coal mining 108 17 256 160 1641 95 097
Oil and gas extraction 50 6714 134 710 105 749
Iron ore mining 19 4525 238 412 91 050
Copper ore mining 14 3864 276 290 75 052
Gold ore mining 89 8096 91 481 59 412
Mineral sands mining 11 1679 153 77 45 861
Silver/lead/zinc 9 2265 252 216 95 364
Other metal mining 17 2628 155 222 84 475
Other mining 554 5827 11 296 50 798
Services to mining 469 13 823 29 885 64 024
Total 1340 66 677 50 5229 78 423

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er
il

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FIG 8.4 - Average wages and salaries in the Australian mineral industry 2000-01.

Occupational and educational structure

TABLE 8.5
The best source of these data is the national census conducted The occupational structure of employment in the Australian
every five years. The information in Table 8.5 shows the strong mineral industry at the 2001 census. (Source: Australian
representation of professionals (15.5 per cent), associate Bureau of Statistics, 2002a).
professionals (10.4 per cent) and blue-collar workers (57.1
per cent) in the industry at the time of the 2001 census. The large Category Number Percentage
majority of these groups work in operational roles, though some Managers and administrators 6469 8.6
professionals are in head office positions. One would expect
white-collar workers in the industry to be more heavily Advanced clerical and service workers 1765 2.3
represented in head office positions. Intermediate clerical, sales and service 3881 5.2
Using 2001 census data, Hall (2003) estimates that the number workers
of mineral sector workers who held university degrees was Elementary clerical, sales and service 461 0.6
12 930. Representing 17.3 per cent of the workforce, these workers
compares with the national average of 28 per cent. It reflects the White collar 12 576 17.0
reality of a small, well-trained and professional workforce that
Professionals 11 646 15.5
has enabled Australia to establish and sustain an internationally
competitive resources sector. Associate professionals 7798 10.4
Professional 19 444 25.9
Location issues Tradespersons and related workers 15 258 20.3
Workers in the minerals and energy sectors generally live in the Intermediate production and transport 24 956 33.2
states or territories where they work. The data5 in Table 8.6, also workers
Labourers and related workers 2946 3.9
5. Data presented in ABS (2002a) excluded employment in the services Blue collar 43 160 57.1
to mining sector from their state and territory employment table and
hence census data has been used instead. Total 75 178 100.0

Australian Mineral Economics 79

CHAPTER 8: THE MINERAL SECTOR WORKFORCE

derived from the 2001 census, reflect the quite different

TABLE 8.6
economic geography of the resources sector in comparison with
Mineral sector employment in Australian states and territories – the remainder of the Australian economy. Western Australia and
2001 census. (Source: ABS, 2002b).
Queensland, which accounted for less than 30 per cent of
State Mining employment Total employment national employment, had more than 60 per cent of mineral
sector employment.
2001 % 2001 %
Census Census While the majority of mining professionals and workers
(’000) generally lived outside of metropolitan areas, the influence of
fly-in, fly-out work patterns is reflected somewhat by the
New South Wales 14 875 19.85 2748 33.13
information in Table 8.7. Interestingly, more than half of the
Victoria 4456 5.95 2082 25.10 metro-based managerial and professional mining workforce
Queensland 19 256 25.69 1569 18.92 resided in Perth.
South Australia 3825 5.10 635 7.66
Western Australia 28 736 38.34 829 9.99
IMPORTANT MINERAL SECTOR WORKFORCE
ISSUES
Tasmania 1600 2.13 182 2.19
Australian Capital 67 0.09 160 1.93 Gender imbalance
Territory
Mining has traditionally been a male-dominated industry in
Northern Territory 2200 2.94 90 1.08 Australia. This shows through strongly in the 2001 census. As
Total 75 015 100 8295 100 can be seen from Table 8.8, the ABS estimated that 86.4 per cent

TABLE 8.7
Residence patterns of mining personnel at the 2001 national census. (Source: ABS, 2002b).

Area Managers Professionals Other operational Other administrative Total

Sydney 364 393 1156 278 2191
Melbourne 463 788 765 428 2444
Brisbane 542 963 1325 549 3379
Perth 1660 3632 6389 1664 13 345
Adelaide 203 526 741 286 1756
Canberra 7 23 38 6 74
Hobart 11 25 79 8 123
Darwin 42 89 372 49 552
Total metro 3292 6439 10 865 3268 23 864
Newcastle 216 820 2973 158 4165
Wollongong 98 292 946 47 1383
Geelong 13 11 56 5 85
Ballarat 10 14 23 8 55
Bendigo 18 37 49 6 110
Gold Coast 40 75 172 44 329
Sunshine Coast 21 55 129 8 213
Toowoomba 12 13 101 13 139
Rockhampton 16 37 163 28 231
Mackay 64 149 707 66 996
Townsville 54 224 292 47 617
Cairns 25 85 151 17 278
Launceston 12 33 122 8 175
Mandurah 42 186 741 65 1034
Major other urban 641 2051 6625 455 9810
Eastern Goldfields 247 879 2187 212 3525
Broken Hill 35 67 424 18 544
Mount Isa 104 401 1493 92 2090
Port Hedland 70 280 683 54 1087
Karratha 70 324 764 117 1275
Regional mining centres 526 1951 5551 493 8521
Other 1947 1112 28 150 1767 32 983
Total non-metro 3114 5094 40 326 2780 51 314
Australia 6406 11 533 51 191 6048 75 178

80 Australian Mineral Economics

 CHAPTER 8: THE MINERAL SECTOR WORKFORCE

TABLE 8.8 TABLE 8.9

Gender balance in the Australian mining industry – 2001 census. Gender balance in selected Australian mining towns 2001.
(Source: ABS, 2002b). (Source: ABS, 2002a).
Men Women Total % Male Men Women Male/Female
New South Wales 13 777 1148 14 925 92.3 ratio

Victoria 3588 932 4520 79.4 Western Australia

Goldfields
Queensland 16 974 2156 19 130 88.7
Kalgoorlie Boulder 15 258 13 561 1.13
South Australia 3286 661 3947 83.3
Coolgardie 2314 1926 1.20
Western Australia 24 073 4953 29 026 82.9
Yilgarn 1123 811 1.38
Tasmania 1468 111 1579 93.0
Leonora 2123 829 2.56
Northern Territory 1607 246 1853 86.7
Laverton 1560 504 3.10
ACT 61 8 69 88.4
Pilbara
Total 64 834 10 215 75 049 86.4
Roebourne 8762 7214 1.21
Port Hedland 7192 5903 1.22
of workers in the industry were men. Though this percentage has
apparently been falling, it reflects continuing male domination. Ashburton 3860 3030 1.27
It is important, however, to see this in a broader context. The East Pilbara 4091 2708 1.51
percentages of men in the formal mining sector in Australia are Murchison
not dissimilar with those in the major mineral exporting nations
such as Canada, Brazil and Chile. Indeed, the Australian male Meekatharra 1113 699 1.59
percentages appear to be slightly less than in these nations. South West
Because the mining industry dominates the economies of Collie 4242 4158 1.02
many remote towns in Australia, male to female ratios in excess New South Wales
of one and sometimes as high as two or three are not unusual.
With their broader employment bases, the larger mining towns Broken Hill 9923 10 348 0.96
reflect a more even balance between the sexes. A brief indication Cobar 2700 2462 1.10
of this continuing imbalance appears in Table 8.9, derived from Queensland
the Extended Regional Profiles of Local Government Areas at
Mount Isa 11 545 10 090 1.14
the 2001 Census. There is further discussion about Australian
mining towns in Chapter 18. Cloncurry 3097 1733 1.79
If gender balance in the industry is a desirable goal, then Belyando 5467 4418 1.24
progress towards it has been slow. More women now study in Tambo 342 300 1.14
disciplines such as geology (perhaps a third of students entering South Australia
classes) and metallurgy than previously but the professional
mining disciplines remain dominated by men. Roxby Downs 2190 1620 1.35
Tasmania
Maintaining a supply of well-trained Queenstown 2961 2557 1.16
professionals Northern Territory
Because it plays a leading role in the world mining industry, Jabiru (NT) 904 867 1.04
Australia has become a major supplier of mining professionals. Tennant Creek 1637 1651 0.99
Like their Canadian counterparts, large and small Australian
mining and exploration companies now operate throughout the
world. Maponga and Maxwell (2000) observed that, by 1995, member companies of the Minerals Council of Australia began
Australian-based resource companies operated in more than showing major concern by the late 1990s6.
seventy nations. While the Asian economic crisis and an Their response was to produce a major report, Back from the
associated drop in mineral prices in 1997 led to a dramatic Brink: Reshaping Minerals Tertiary Education (Minerals
decline in offshore activity, there has since been a strong Council of Australia, 1998). Quoting from the work of Nemitz in
recovery. his contribution to this report, Brady (p 140) observed that
The cyclical nature of mining and the general decline of the universities in the European Union produced about 700 mining
industry in Europe and the United States have, in recent years, engineering graduates in 1990, universities in the USA and
adversely affected the supply of new mining graduates from Canada produced about 250 and Australian universities about
these places. Because Australian mining schools were struggling 1007. Yet, the output from European schools, which provided
to meet the shortfall previously supplied from these sources, their graduates to a broader range of areas than mainstream
mining, then entered a period of major decline, with many
closing or merging with one another. In response, Brady
6. The Minerals Council of Australia is the national representative body estimated that the numbers of graduates from Australia’s six
of state-based Chambers of Minerals and Energy that represent the mining departments had only grown to an estimated 175 by
major mining companies. They account for the large majority of
19978.
production and employment in the Australian mining sector.
The authors of one of the other appendices, ‘Minerals Tertiary
7. Barry Brady was, at this time, Professor of Mining Engineering at Education – A Snapshot’ (Minerals Council of Australia, 1998,
the University of Queensland. pp 99-120) estimated that in 1995, 1996 and 1997, the six
8. University of Queensland, University of New South Wales, university mining engineering departments produced 104
University of Wollongong, University of Ballarat, University of graduates annually. The nine metallurgy/materials departments
South Australia and the Western Australian School of Mines (Curtin produced 160 graduates per year and the 23 geology departments
University of Technology). produced 463 graduates annually.

Australian Mineral Economics 81

CHAPTER 8: THE MINERAL SECTOR WORKFORCE

TABLE 8.10 The growth of fly-in, fly-out workforces

Changes in the employment of geologists and mining engineers
between the 1996 and 2001 national censuses in Australia. A notable recent trend in the formal mining sector has been the
(Source: Hall, 2003; ABS, 2002a). rise of ‘fly-in, fly-out’ work practices. Storey (2001a) defines
fly-in, fly- out (FIFO) mining operations as:
1996 2001 % change
those which involve work in relatively remote
Geologists/Geophysicists locations where food and lodging accommodations
Mining 2701 2441 -9.6 are provided for workers at the worksite, but not
Consulting engineering services 344 366 6.4 their families. Schedules are established whereby
employees spend a fixed number of days working at
Other business services 1350 1303 -3.5
the site, followed by a fixed number of days at
Other industries 941 957 1.7 home. What differentiates this form of organization
Total geologists 5336 5067 -5.0 from other work involving periodic absences from
Mining engineers home are the regular patterns of work onsite
followed by a period offsite and the nature of the
Mining 950 1148 20.8 accommodation arrangements.
Consulting engineering services 254 367 44.5
As Storey and others have noted, the FIFO terminology is
Other business services 101 90 -10.9 misleading because some workers do not fly to the mine site or
Other industries 324 363 12.0 the oil rig at which they work. They drive in, travel by bus and
Total mining engineers 1528 1878 22.9 some even come by boat or hovercraft.
The incidence of FIFO work practices has become more
pervasive over the past 20 years, with perhaps 70 mines in
While recognising the positive record of Australian remote parts of Australia now fully staffed in this way. The
universities in producing more graduates in the mining-related practice now applies more and more throughout the world such
disciplines in the preceding two decades, the authors made some as in Canada, South America, Asia and Africa. It means
major recommendations that sought to serve the local industry in particularly that cities like Perth, but also Brisbane, Melbourne,
the longer term. Townsville, Mandurah and Cairns, provide the residences of
An important result of these recommendations was the managers, mining professionals and other operational personnel.
establishment of the Minerals Tertiary Education Council
The rise of the FIFO work camp has been driven in part by
(MTEC). Utilising significant contributions from member
market forces and the unwillingness of government to contribute
companies in the Minerals Council, MTEC has worked to
enhance the quality of undergraduate and postgraduate minerals to the development of short-lived and even long-term remote area
education. In particular it has done so by supporting the activities mining towns.
of selected universities that have agreed to pursue its agenda for Storey (2001a, p 136) identifies five key factors in the rise of
change and improvement. FIFO arrangements. These are:
During the intervening period, the cyclical nature of the • the absence of government financial support for new town
mining industry has continued. Precipitated by the Asian crisis, development;
and in the wake of poor mining company profits over several
years, there was a dramatic decline in mineral exploration • longer lead times needed for new town approvals and
budgets in the late 1990s and the early years of the new construction;
millennium. This led to a dramatic decline in employment of • environmental implications of new town construction;
geologists and an associated departure of many, either into other
• administrative implications of managing a town as well as a
parts of the industry or away from it all together. During 1998
mine; and
and 1999, as many as 1000 geologist positions may have
disappeared throughout Australia. • increased costs associated with town closure, once the
Utilising data from the 1996 and 2001 national censuses, Hall resource is exhausted and is no longer economic.
(2003) generates the data in Table 8.10. These show a decline of He points also to five further factors that have encouraged the
269, or five per cent, in the number of geologists employed practice. They are:
between 1996 and 2001. Almost all of this decrease was due
directly to mining operations. Other areas, including business • Improved quality and a relative decline in communication
services (geological consultants), remained relatively steady. The costs (ie telephone, fax, email and internet facilities).
number of mining engineers employed increased by 20.8 per cent • Improvements in aircraft and aircraft safety, and relatively
over the same period, while the number of consulting mining lower air travel costs. This has led to dramatically increased
engineers increased by almost 45 per cent. air traffic flows from places like Perth, both for scheduled
A general impression is that Australian universities coped and charter carriers. One relevant example of this is the rise
better in meeting domestic mining industry requirements for in air travel to cities such as Kalgoorlie.
professionals during the 1997-2001 period. However, this was a • A lower turnover and level of absenteeism in FIFO
period of depressed activity. The fortunes of the industry workforces than in resource towns. Unless workers are really
changed significantly after 2002. Driven by China’s voracious sick, they will tend to fly to site for extended work periods.
demand for minerals and energy, the prices of major minerals
rose dramatically and remained high between 2003 and 2005. • Access to a larger supply of qualified labour, for example to
With large investment in new mines, expansion of existing the more than 60 per cent of Australia’s population that lives
operations and increased exploration activity, a national and in the five main cities. FIFO provides access to a much
global shortage on mining professionals emerged again. Captains broader potential group of workers.
of industry lamented the situation. • A preference for metropolitan over rural living by many
While the activities of MTEC and the Australian universities workers and their families. This arises in particular because
have been moving forward, it is clear that providing a steady of better health, educational and social services in major
stream of well-trained professionals to the mining industry is a centres. Major cities and coastal centres typically also have
continuing challenge. better climates.

82 Australian Mineral Economics


We also need to see FIFO work practices in a broader context.
Working patterns have been changing throughout society, with
many forms of ‘non-traditional’ work patterns now common. In
his monograph, Workers Without Traditional Employment: An
International Study of Non-standard Work, John Mangan points
to a wide variety of newer working arrangements include leased
or franchised workers, outworkers, teleworkers, freelancers and
portfolio workers. He argues that:
Those in alternative employment relations are
now in such numbers that they can no longer be
regarded as peripheral to the main labour
market.
FIFO began to oil-rigs in the Gulf of Mexico in the late 1940s.
It has been widely used in the offshore oil and gas sector ever
since that time, in the North Sea, the Atlantic, off Indonesia and
in the Bass Strait and on the North West Shelf. The first onshore
FIFO work practices began at Polaris in Canada’s High Arctic
region. In Australia, the first mine to utilise the practice was the
Argyle mine in the Kimberley region of Western Australia (WA).
It began operations in 1982. Since that time, the number of FIFO
mines in Australia has grown to about 70.
There was quite dramatic growth in the practice during the
1980s. The then WA Department of Mines reported in 1991 that
there were 26 FIFO operations in that state employing 4220
people. Our estimates are somewhat higher than that. They
suggest a figure of closer to 7000 people following FIFO rosters
at that time in WA (see Table 8.11).
TABLE 8.11
Estimates of FIFO workforces in Western Australia. (Source:
WA Department of Industry and Resources, Western Australia
Minerals and Petroleum Statistics Digest, 1990-91 and 2003-04).
1989/90 2002/03
Estimated number of workers
Resident 29 506 19 000
FIFO 7021 17 000
Total 36 527 36 000
By 2003-04 the number of FIFO mine and oil-rig workers in
WA had risen to 19 000 – more than 50 per cent of total mining
employment. There were 51 mines in WA following FIFO rosters
and about 20 in the rest of the country. FIFO work practices are
common in gold mining, oil and gas extraction, diamond and
nickel mining and for base metals exploitation in WA. They do
not apply in the bauxite, mineral sands and coal sectors, which
are located much closer to the Perth metropolitan area. Many
families of coal miners and base metal miners in Central and
North Queensland prefer to live at the coast where the weather
and services are much better.
There are elements of FIFO mining in Papua New Guinea,
Chile, Indonesia, and in several African nations. There is
considerable potential for the practice in many of the nations of
the former Soviet Union.
There has been much discussion about the social implications
of FIFO work practices in mining for workers and their families.
Storey (2001b) argues that commentators perceive FIFO:
to have negative social consequences for
individuals, families, and by extension, for the
communities in which they live, by contributing to:
• greater alcohol and drug abuse,
• family violence and break-ups,
• parenting problems, and
• reduced community involvement.
Australian Mineral Economics
CHAPTER 8: THE MINERAL SECTOR WORKFORCE
Yet, people who choose this form of employment often do so
because they like it. Sibbel (2004) reports that FIFO workers
typically see both positive and negative points about the practice.
In following typical 14/7 (14 days on, seven days off), 9/5,
5/2/4/3 and other rosters they see the following positive points
about FIFO. Work and home are separate. Salaries are excellent.
Longer breaks provide an opportunity to socialise. There is more
opportunity to play a supervisory role on the job. Because
residences are set, it is quite easy to change employers. Families
are often very supportive.
Negative points include roster impacts on relationships,
missing out on family activities (birthdays, children’s sporting
events, etc), less involvement with the community, inability to
attend to home emergencies, time-consuming travel, general
tiredness because of long shifts, fear of flying, and the problem
of binge drinking at the end of work rosters.
SUMMARY AND CONCLUSION
Discussion in this chapter considered the size and distribution of
the global minerals and energy sector workforce. It then focused
more particularly on the Australian industry’s workforce and a
range of forces that have recently been influencing it. In
conducting this exercise, a major aim has been to appreciate
some of its dimensions more closely.
It was noted earlier that the labour and capital intensity of
mining differs between nations, depending on their stage of
economic development and the extent of their transition from
socialist to free enterprise operating environments. Also noted
was the difference in labour intensity between the formal and
small-scale mining sectors.
Our indicative estimates suggested that the world’s mining
workforce in 2001 was almost equally divided between the formal
and small-scale and artisanal sectors. Although close to 20 million
people worked in the minerals and energy sector throughout the
world, the workforces in major mining nations such as Australia,
Canada and Chile are small and will remain that way.
Even though the sector has recently contributed more than four
per cent annually to GDP in Australia and more than 30 per cent
of our exports, it now employs only about 0.7 per cent of the
workforce. This contrasts with the situation at the turn of the
20th century when mining employed an estimated eight per cent
of the workforce.
The value added per employee in the Australian minerals
sector now exceeds $500 000 per annum. Despite wide swings in
the mining cycle, the wages of workers in the sector are more
than double the national average. While this dramatic difference
reflects the specialist training of workers and their responsibility
in operating expensive capital equipment, it is also a reward for
working in harsh environments, and living in or commuting to
remote locations.
Discussion concluded with a review of some topical mineral
sector workforce issues. These included the historical issue of
gender imbalance of mining sector workers, the challenges of
maintaining a supply of well-trained professionals, the decline of
unionism and the growth of FIFO workforces.
These and related issues will have an important continuing
influence on the structure of mineral sector workforces both in
Australia and more broadly as the economic geography of
mining moves towards other parts of the world in the coming
decades. The industry will continue to operate in a dynamic and
changing environment. Those who choose to work in the sector
will need to adapt continuously.
REFERENCES
Australian Bureau of Statistics, 2002a. Mining operations Australia
2000-01 (Catalogue No 8415.0) (Australian Bureau of Statistics:
Canberra) [online]. Available from: <http://www.abs.gov.au>. Date
accessed: 8 May 2006.
83
CHAPTER 8: THE MINERAL SECTOR WORKFORCE
Australian Bureau of Statistics, 2002b. National census of population and
housing 2001 (Australian Bureau of Statistics: Canberra) [online].
Available from: <http://www.abs.gov.au>. Date accessed: 8 May 2006.
Blainey, G, 2003. The Rush That Never Ended: A History of Australian
Mining, fifth edition (Melbourne University Press: Melbourne).
Hall, B, 2003. The size of the bucket 2001: Employment trends in the
Australian minerals sector, report to The Australasian Institute of
Mining and Metallurgy [online]. Available from: <http://www.
ausimm.com.au/policy/bucket.pdf>. Date accessed: 8 May 2006.
Hilson, G M, 2002. Delivering aid to grassroots industries: A critical
evaluation of small-scale mining support services, Minerals and
Energy: Raw Materials Report, 17(1):11-18.
International Labour Organization, 2004. Yearbook of Labour Statistics
2004, 63rd issue (International Labour Organization: Geneva).
Maponga, O and Maxwell, P, 2000. The internationalisation of the
Australian mineral industry in the 1990s, Resources Policy,
26(4):199-210.
Minerals Council of Australia, 1998. Back from the brink: Reshaping
minerals tertiary education, Minerals Council of Australia, National
Tertiary Education Taskforce, Canberra, discussion paper [online].
Available from: <http://www.minerals.org.au/__data/assets/pdf_file/
8007/backfromthebrink_exec_summ.pdf>. Date accessed: 8 May 2006.
84
Sibbel, A, 2004. FIFO or residential: Choices for life?, presentation to The
Australasian Institute of Mining and Metallurgy Perth Branch meeting,
held 16 September, Curtin University of Technology, Bentley campus.
Storey, K, 2001a. Fly-in/Fly-out and fly-over: mining and regional
development in Western Australia, Australian Geographer,
32(2):133-148.
Storey, K, 2001b. FIFO mining in Australia: What do we really know
about its social and economic impacts?, mimeo, November, 22 p.
Western Australian Government, Department of Industry and Resources,
various years. Western Australia Mineral and Petroleum Statistics
Digest, 1990-91 and 2003-04 (Western Australian Government,
Department of Industry and Resources: Perth) [online]. Available
from: <http://www.doir.wa.gov.au/mineralsandpetroleum/3B1F0B2
F32EE4593BBAA44D2600B69CC.asp>. Date accessed: 8 May 2006.
World Bank, 2004. The World Bank Group website [Online].
<http://www.worldbank.org>.
Australian Mineral Economics

An Introduction to Mineral Finance
Pietro Guj
Financial Objectives and Financial Management
Sources and Application of Funds
Sources of Equity
The Cost of Equity: Balancing Risk and Return
Sources of Debt
Hybrids Between Equity and Debt
Project Finance
The Financial Structure of Mining Companies
Conclusions
FINANCIAL OBJECTIVES AND FINANCIAL
MANAGEMENT
Most analysts maintain that the financial objective of an
exploration or mining enterprise is to maximise the value in the
hands of its current ordinary shareholders. Whether decision
makers in the enterprise achieve this objective depends, in the
first instance, on the quality of the orebody in terms of its size,
grade, metallurgical and geotechnical characteristics. A sound
mine plan to achieve such an outcome, however, can only
become reality if mine managers and professionals are
competent, labour is skilled, plant, equipment and materials are
appropriate, and, above all, there is adequate investment and
working capital.
Because of its capital-intensity and the requirement for large
initial investments in mine developments, the mining industry
has a voracious appetite for capital. Yet some common sources of
borrowing are not easily accessible to it because of the inherent
risk and the variability of its cash flows. Compared to other
sectors of the economy, mining companies generally must rely
more on either equity or specialised financial arrangements such
as project finance, or both together.
The unique characteristics of the mining industry are also
reflected in the specific style of financial management that
characterises successful mining enterprises.
The focus of this chapter is on four main areas:
1. the main financial management principles and their
relevance to the mining industry;
2. the various sources of both equity and debt funds used by
the mining industry, their cost and availability;
3. the more specific area of project finance; and
4. the financial structure of mining companies and the
trade-off between financial leverage and financial risk.
Australian Mineral Economics
CHAPTER 9
Discussion will consider the general financial context within
which mines are successfully developed and operated and then
sets the scene for the following three chapters, which deal with
specific aspects of mine finance in more detail.
Financial managers of mining companies are particularly
concerned with two distinct types of decision. These are:
• the investment decision, and
• the funding decision.
Another important decision concerns the proportion of profits
devoted to shareholder dividend payments. Traditionally, the
capital-hungry mining industry has tended to be parsimonious in
terms of dividends. Many exploration and small mining
companies never pay dividends and their shareholders must
derive their return entirely from capital gains when selling their
shares.
The investment decision is concerned with determining which
asset base is most appropriate to achieve the financial-return
objectives of an enterprise. A company’s Board of Directors sets
this at a level sufficiently high to attract and retain adequate
investment capital from the owners or shareholders given the
degree of risk that they face. To build, diversify and maintain an
optimal portfolio of exploration, development and mining
projects and other assets entails occasional asset acquisitions and
disposals. A diversified portfolio effect as will be discussed in a
later section, means that the combination of selected assets:
• adds greater value for the shareholders than the sum of the
returns on the individual projects; and
• results in lower combined risk exposure; or
• both of the above.
The process of selecting capital investments is sometimes
referred to as capital budgeting.
87
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
So investment (and disinvestment) decisions are the main
determinant of the assets, which appear in a mining company’s
statement of financial position (balance sheet) and indeed of any
enterprise.
The time focus of investments is also a major consideration in
financial management. While the mining industry is
capital-intensive and its assets long-lived (ie fixed or non-current),
it is also critical to manage cash and other short-term (current)
assets and liabilities to maintain adequate liquidity.
Inability to satisfy any debt as it becomes payable, is often the
reason why enterprises are placed under administration/liquidation.
Liquidity problems, rather than lack of net asset worth
(solvency), push companies into liquidation. This is because
most of their non-current assets are illiquid, ie not capable of
being sold on a short time scale. Liquidity is crucial in the case
of mining because of the high variability of cash flows due to the
general volatility of commodity prices and revenue.
The funding or financing decision, by contrast is concerned
with how to fund the above assets, whether with:
• equity (ie owners’ or shareholders’) funds; or
• debt (bank loans or other financiers’ and creditors’ funds) in
various forms.
These funding sources appear as liabilities (both short and
long term) and as shareholders’ equity in the balance sheet. As
the name implies, the balance sheet must balance. As a
consequence, total liabilities plus shareholders’ equity must
equate to the value of the corresponding assets. In effect,
shareholders’ equity represents the balancing item. Thus, the
shareholders have control of but bear the ultimate risk of the
enterprise, although their risk is limited to their investment in it
and does not flow through to their other assets, personal or
otherwise. Of course the value of the assets must equal or exceed
that of the liabilities. When this is not the case, the enterprise is
insolvent. Directors who continue trading in the knowledge that
their company is insolvent commit a punishable crime.
Assets = Liabilities + Shareholders’ Equity
is the fundamental financial accounting equation. Every financial
transaction is either an asset, a liability or an equity account
entry in the chart of accounts (financial system) of the firm.
The funding decision also encompasses determining which
financial structure (ie which proportion of equity and debt) is
most appropriate for any specific company or project. To the
extent that interest is a tax-deductible expense, using debt
reduces the amount of tax payable and as a consequence
improves the return on the equity funds invested. This is the
financial leverage effect. As discussed later in more detail, the
use of excessive debt introduces an additional element of risk.
This is known as financial risk. It differs from the technical and
marketing risk inherent in any mining project. Project finance is
sometimes provided on a limited recourse basis in which case, as
discussed below, some of the shareholders’ risk is transferred to
the lenders.
As will be seen below, the search for an optimal financial
structure is a complex and somewhat ambiguous field of academic
research on which opinions are divided.
The role of financial managers
Financial managers play a significant corporate role in securing
the necessary funds and ensuring that they are used effectively
and efficiently in achieving the financial objectives set by their
Board of Directors.
Peirson et al (2004, p 7) provide an exhaustive list of their
duties and services. They include:
88
• Group accounting, including developing and implementing
financial policy and maintaining accounting systems
supporting both consolidated financial accounting reports
on an accrual basis and operational management
accounting reports compiled on a cash basis.
• Treasury operations, including both management of current
assets and liabilities (ie cash management) to ensure an
appropriate level of continued liquidity and obtaining and
servicing long-term finance through borrowing (including
project finance), leasing, retention of earnings after payment
of dividends and issuing of shares and other securities. These
also include managing relationships with corporate bankers.
• Tax services, including tax advice, compliance and
optimisation.
• Corporate finance services, including the financial analysis
and evaluation of exploration, development and mining
projects and other investment opportunities, contribution to
the financial components of pre-feasibility and feasibility
studies and implementation of selected projects, advice on
related strategic financing issues and on possible mergers and
acquisitions.
• Risk assessment and management, relating to both project
and market risk. This involves identifying and assessing
sources of risk through internal audits to determine their
potential impact and likelihood of occurrence. This helps in
formulating the company’s risk-management policy of
securing an appropriate level of insurance, commodity prices
and exchange rates hedging to shelter from those risks that
the company is less capable to or does not wish to bear.
• Investor relations with shareholders, investment analysts
and the public as well as satisfying all the disclosure and
other requirements of the Australian Stock Exchange (ASX).
• Financial planning, forecast and construction of corporate
and project financial models capable of generating short,
medium and long-term forecasts of the company’s finance
under different development scenarios and various economic
and other assumptions.
To the extent that this monograph focuses on economic and
financial analysis rather than financial accounting, further
reference to this discipline is only made when it is relevant to the
first two topics.
Most exploration and mining professionals probably require a
relatively superficial knowledge of the principles and practice of
financial accounting and the intricacies of reporting on an
accrual basis. A reasonable understanding of management
accounting on a cash basis generally satisfies their immediate
financial management needs. By contrast, to be effective
strategic managers, they need a relatively deep understanding of
corporate finance, financial planning and project modelling and
evaluation. Focus will therefore be on these latter topics in the
rest of this, and in the following, chapters.
SOURCES AND APPLICATION OF FUNDS
General considerations
Three types of activities, reported in the sources and
application of funds (or cash flow) statement, generate or
consume funds (cash). They are:
• operations – hopefully generating more cash (through
revenue and depreciation) than they consume in the
corresponding recurrent expenses and tax payments;
• investment activities – increasing tangible and intangible
assets consumes cash, while asset sales and joint venture
farm-outs increase cash; and
Australian Mineral Economics

• financing activities – either issuing new shares, or drawing
down loans (ie increasing liabilities), or both activities,
generate cash, while repaying loan principal or returning
capital to the shareholders by means of share buy-backs
(while reducing liabilities) consume cash.
The first two activities can be sources of internal funding,
while the last will generate external funds.
As can be seen in Figure 9.1, each year the Directors
appropriate cash (funds) from the company’s operations
equivalent to its profit less dividends (ie retained earnings for the
year), plus depreciation, plus the difference between the opening
and closing balance of all the recurrent items accrued in the
balance sheet.
FIG 9.1 - Schematic representation of the sources and application
of funds.
They make further adjustments to account for the cash flow
relating to investment and financing activities, which collectively
will capture all changes in assets and liabilities generating or
consuming cash. For example, a reduction in non-cash assets (eg
the sale of a property or equipment) or an increase in liabilities
(eg the drawing down of a new loan) will generate cash. By
contrast an increase in fixed assets (eg a new mine development)
or a reduction in liabilities (eg repayment of a loan principal)
will consume cash.
The cash outflows relating to the acquisition of significant
depreciable capital items occur in discrete ‘lumpy’ amounts, even
though these assets, as inputs to on-going mine production, have
the capacity to generate benefits over future periods during their
useful lives. A fundamental principle of financial accounting is
to match revenue with the corresponding expenses incurred to
generate it in each period. This includes the cost of ‘consuming’
fixed assets acquired through lumpy investments in the past. This
item of expense, which is called depreciation, is not a cash cost,
but merely an accounting convention attempting to match
revenue and expenditure in each reporting period.
In the case of the mining industry, given its capital-intensity
and the presence of accelerated depreciation, the amount of cash
appropriated each year against depreciation can be considerable.
In some cases, particularly during its early years, the bulk of the
cash generated by a mining project is attributable to depreciation
and a company may have significant cash flow even if it makes a
financial accounting loss.
Investment activities are central to the mining industry given
its capital intensity and generally long project lives. The
investment characteristics at the exploration stages, however, are
very different, as will be seen in the coming chapters, from those
at the development and operational stages.
Main sources of funds
A company’s main sources of financing fall into two broad classes:
• Equity (E) or owners’ or shareholders’ funds. Shareholders
have control over the affairs of the company but bear the
ultimate risk for the firm/project.
Australian Mineral Economics
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
• Debt (D) or banks’ or financiers’ funds, which are generally
secured by:
• a senior floating claim on the firm’s assets,
• specific collateral,
• the project to be funded, or
• are unsecured.
There is also a third (albeit quantitatively less significant)
category of hybrid funds, which includes financial instruments
displaying both the characteristics of equity and debt, such as
preference shares and convertible notes.
Major integrated mining houses with strong, diversified
balance sheets and large annual cash flows have little difficulty
in raising debt funds either on:
• their balance sheet (eg conventional loans, bonds, notes and
debentures); or
• from specific project loans.
Without the backing of a profitable operation, small to
medium-size exploration companies can only rely on equity as
their main source of funds even though its is complex and, as it
will be seen, expensive to raise.
The type of funding must be appropriate to the specific stage of
the project in the mineral cycle and its related risk. Companies
finance high-risk exploration primarily with equity. They use a
mixture of debt and equity for medium-risk development projects,
with high levels of debt early in the project life decreasing as the
project cash flow improves. Operators of lower-risk, established
mining operations seek an optimal and steady balance between
equity and debt that minimises taxes and leverages shareholders’
returns at an acceptable level of financial risk.
SOURCES OF EQUITY
General considerations
The prevailing ‘outsider’ system of corporate ownership strongly
influences corporate financing in Australia (Trench, 2002). Similar
situations apply in the United States, the United Kingdom and
Canada. The Australian system is characterised by rapid
ownership dispersion, stock market floats and relatively weak
relationships between companies and financing institutions. By
contrast in Germany, France, Japan and Chile (where an ‘insider’
system operates) ownership is concentrated with few share floats
and strong relationships with banks and financiers.
Furthermore, traditionally the exploration and mining sector
has relied largely on equity to fund its operations, with average
debt for this sector historically seldom exceeding 40 or 50 per
cent of the total funds employed.
The resources part of the equity market in Australia does not
display what could be considered a ‘strong’ or even ‘semi-strong’
form of efficiency in terms of the speed of price adjustments to
reflect emerging information (Brealey and Myers, 1996), with
the price of mining shares appearing to lag emerging
information. This generates high price volatility and amplifies
general market movements and cycles.
While equity markets in Australia are well developed and
satisfy the significant demand arising from the mining industry,
companies also obtain significant funds off-market.
Off-market sources of initial equity
Aside from internally generated funds, which probably represent
the lowest-cost source of capital, new off-market equity funds
include:
• privately sourced seed and venture capital from ‘business
angels’ and other venture capitalists;
89
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
• other lower-risk and generally more significant off-market
placements;
• farm-outs/joint ventures; and
• royalty-based finance arrangements.
‘Business angels’ are generally astute technical or financial
specialists investing up to a few hundreds of thousands of dollars
for five to ten years to help detect and address any missing
critical success factor and develop high-risk high-return
opportunities to the point where they can seek formal external
funding or be profitably sold.
The main advantage of venture capital is that it is often the
only source of capital available to start up a mining project.
Based on a persuasive business plan, venture capitalists will
invest amounts in the order of $0.5 to $10 million for between,
say, three and seven years, aiming to achieve high capital gains
by disposing of their investment at a favourable time, rather than
maintaining their investment in the company and waiting for
eventual dividends.
Venture capital has, however, some drawbacks. For instance
the original project promoters are likely only to being able to
retain a minority position in their project. They also experience
the added pressures of working with an active board with a
contractual attitude towards management and a tendency to go
well beyond the provision of general direction and governance
into the sphere of day-to-day technical and managerial decisions.
From a company’s point of view, equity funding provided by
venture capitalists presents a number of significant advantages:
• Firstly, it may be the only way of funding higher-risk
projects.
• Secondly, unlike the obligation to pay interest on debt, there
is no obligation to pay a dividend on ordinary shares, even
though this would be desirable at some stage in the project
life – similarly there is no provision for repayment of initial
shareholders’ capital contributions as contrasted to principal
repayment at the maturity date of a loan.
• Thirdly, the shareholders’ liability is also limited to their
investment in the company. This means that their liability
does not extend to other personal assets if, in case of
liquidation, the total assets of the company are insufficient to
satisfy all the creditors’ claims.
There are, however, some disadvantages:
• Firstly, there is the dilution effect of additional equity issues.
By contrast debt finance does not cause dilution of ownership.
• Secondly, equity issues are complex and entail high
transaction costs relating to the preparation of a prospectus
and related underwriting.
• Thirdly, funds may not be available when needed as their
availability is a function of economic and commodity price
cycles. Successful floats and issues are generally restricted to
boom times.
On-market sources of equity
There are a number of ways to raise new equity ‘on-market.’
These include initial public offerings (IPOs) and subsequent
equity raisings (see Table 9.1).
For new mining companies, IPOs typically occur on the
Australian Stock Exchange (ASX) but also on overseas stock
exchanges such as the Toronto Stock Exchange in Canada or the
London Alternative Investment Market (AIM). The share issues
in these IPOs can include:
• ordinary fully paid shares generally represent the bulk of the
equity funds sought and largely determine the financial
structure of the company;
90
TABLE 9.1
Equity funds raised on the Australian Stock Exchange in financial
2003-04. (Source: KPMG, 2004.)
Source A$ billion
IPO (150) 9.9
Rights 10.2
Placements 8.5
Dividends re-investment 5.2
Employees schemes 2.9
Total 37.0
• contributory or partly paid shares, while popular, are
quantitatively subordinate and are used to provide a reliable
future source of equity funds through calls on shareholders
when funds are actually needed;
• preference shares conferring the payment of dividends, that
are often fixed, to their holders ahead of ordinary
shareholders, are issued to attract funds from interested but
more risk-averse potential investors; and
• options are frequently used as a sweetener for equity issues
or as a reward to executives and other employees designed to
encourage them to work in ways that enhance the company
value.
Subsequent equity raisings include:
• right issues,
• placements,
• dividend re-investment, and
• employees’ schemes.
Bonus issues and share splits by contrast do not raise new
equity, and even though they were once very popular, they are
now very uncommon.
In Australia capital raisings are generally highly regulated and
costly. The Corporation Act 2001 and ASX rules require
significant disclosure documentation in the form of a prospectus
and either a profile statement or an offer information statement
(for raising small amounts generally less than $5 million). Some
offers are exempt from disclosure requirements.
According to Peirson et al (2004) the major costs in an IPO
include:
• Compiling and printing a prospectus, including independent
experts’ reports at $300 000 to $500 000.
• Stockbroker underwriting of the IPOs or of subsequent share
issues, or both. Underwriting costs can vary between over
one per cent and seven per cent of the size of the float. This
percentage depends on the standing of the company and
whether the IPO price has been set at a realistic level and
averages around four per cent.
As a large proportion of floating costs is independent from the
size of the float, the total cost for a large float ranges between
two and six per cent, while small ones absorb a much larger
proportion of the funds raised (between 11 and 23 per cent).
The general investor perception is that subscribing to an IPO is
a strategy for easy money. In reality, only 66 of the 150 IPOs in
2003-04 (44 per cent) were trading at or above issue value by the
end of 2004 even though market conditions were generally
buoyant.
Of the 150 IPOs in financial 2003-04, 55 were for exploration
and mining companies. Forty-seven of these were trading at a
premium within a few weeks of listing, in some exceptional
cases having doubled or even trebled their values. This does not
necessarily indicate that exploration and mining IPOs perform
any better than those in other sectors. It may essentially reflect
Australian Mineral Economics
 CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE

IPO pricing mechanisms and dilemmas. During commodity

Australian Mining IPO s 1996 - 2004
booms, most resources stocks may open at a listing premium
relative to their issue price. This may be because the listing price 30
has been set too low under the risk-averse influence of the
under-writing stockbrokers. Underwriters have a propensity for 25 Frequency
curbing the project proponents’ excessive optimism and would 20

Frequency
sooner sacrifice the potential rewards of a higher-priced IPO than
being exposed to a potentially costly under-subscribed float. Less 15
risk-averse investors are willing to pay positive listing premiums More than
while general market sentiment is buoyant and appetite for 10
A$15M
cyclical stocks high.
5
As will be seen in Chapter 12, this difference between the
fundamental value of exploration and mining assets and their 0
market value (ie the market premium) may represent the

10

13
5

.5

.5
5.

8.
2.
so-called real option value (ROV) of the assets.

11

14
During periods of resources boom such as calendar 2004, there Money raised A$M
is generally a strong investor appetite for cyclical stocks such as
mining companies’ shares. The cyclicality of this demand is FIG 9.3 - Frequency distribution of size of IPOs over the period
clearly shown in Figure 9.2, which portrays the number of IPOs 1996-2004.
of new mineral exploration and mining companies during the
nine calendar years between 1996 and 2004.
Figures 9.4 and 9.5 show that 72.7 per cent (302) of Australian
listed exploration/mining companies have a market capitalisation
NUMBER OF IPOs - 1996 - 2004 (Estimated) of less than A$ 50 million, 22 per cent (91) a mid-capitalisation
45
range between $50 million and $1 billion and only 5.3 per cent
(22) of companies are capitalised at more than A$ 1 billion.
40 Number of IPOs
35
Number of IPOs

30 90
25 80 Frequency
20
Number of companies

70
15
60
10
5 50
0 40
1996 1997 1998 1999 2000 2001 2002 2003 2004 30
Year 20
10
FIG 9.2 - Exploration and mining IPOs are cyclical.
0
0

0
00
5
10

20

30

40

50

75

e
10

20

50

or
There has been a recent trend for companies to finance their
10
M
mergers and acquisitions with shares rather than cash, particularly
late in an economic cycle. Depending on how the offers are Capitalisation A$ Million at Sept. 2004
written (Rappaport and Sirower, 1999) this type of deal is difficult
to evaluate. This is because of the ambiguous signals that the
management of the acquiring company sends to the capital market. FIG 9.4 - The market capitalisation of Australian listed mining
Logic dictates that if they truly believed that their shares were companies, September, 2004.
poised for a great leap forward, they would have been better off
using cash instead of script and benefiting from the impending
increase in its value. A possible interpretation is that they in fact 8
may have considered that their shares were overvalued. 7 Frequency
Number of companies

6
Resource sector IPOs are generally small
5
Excluding an exceptional IPOs raising more than $1 billion, the
4
average of the remaining 149 IPOs in Australia in financial
2003-04 raised just under $60 million. If only resources sector 3
IPOs in that financial year are considered, most resources IPOs 2
were in the $2.5 to $6 million class. Figure 9.3 shows that this is
consistent with a longer term frequency distribution of the size of 1
all exploration and mining IPOs over the period 1996 to 2004. 0
According to the Minmet/Intierra database, in September 2004
5

.5

.5

.5

.5

.5

.5

.5

.5
2.

7.

12

17

22

27

32

37

42

47

there were 415 exploration/mining companies listed in Australia,

of which:
• 251 were producers (200 of these producers are also active
explorers) with a total capitalisation of A$ 221.6 billion; and
• the remaining 164 were pure explorers and accounted for
only A$ 10 billion in market capitalisation.
Capitalisation of companies with value in
excess of A$ 1 billion as at Sept. 2004
FIG 9.5 - The size distribution of Australian resources companies
with capitalisation in excess of A$1 billion, September, 2004.

Australian Mineral Economics 91

CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
The size distribution of mining companies in Australia is
highly positively skewed, with the top three companies
accounting for just under 50 per cent of total market
capitalisation, while the top ten account for 75 per cent. Thus, a
quarter of the value is dispersed among 405 small to
medium-size companies, most of which are not large enough to
become part of the Standard and Poors or ASX index.
This provides an indication of how the relative importance of
the resources sector has decreased in recent years and of how the
Australian market has evolved from being a resources-dominated
market to a financial-dominated market. The authors of Australian
Stock Exchange (2004) report that in 1980, resources represented
approximately 62 per cent of the share market. By 31 December
2003 this had fallen to approximately 17 per cent.
Criteria for inclusion in a stock market index
Few mining companies are included in any of the main stock
market indices in Australia. To be included, a company share
must display:
• liquidity,
• free float, and
• high capitalisation.
These three investable weight factors (IWF) determine which
of the companies listed on the ASX are captured by its various
indices. In September 2004 there were 1540 companies listed on
the exchange.
Only the five largest mining companies are included in the
S&P/ASX 50 and through it in the Standard and Poors Global
1200 index, thus gaining international exposure.
A further ten companies (ie a total of 15) make it to the
S&P/ASX 200 index, which capture 90 per cent of market
capitalisation and is used by many domestic passive fund
managers. Thus the majority of exploration companies are not on
the ‘radar screen’ of large index-using, institutional investors.
In aggregate 36 out of the total listed 415 mining companies
(ie 21 more than in the S&P/ASX 200) appear in the S&P/ASX
300. They are typically small to medium-size mining companies
and their cumulative value is very low given that the additional
100 companies only account for an extra one per cent of market
capitalisation. The remaining 215 small explorer/producers and
just about all of the 164 pure exploration companies do not
appear in any significant index at all.
Most equity funds are sourced from investment institutions
including:
• superannuation funds,
• life insurance companies,
• unit trusts, and
• investment companies.
Some fund managers actively manage their funds with the
objective of maximising returns, albeit under some risk exposure.
But many funds are passively managed or index-bound. That is,
their managers seek to achieve returns equivalent to movement in
a relevant index. Furthermore, most institutional fund managers
are often constrained to invest in certain main S&P/ASX index
shares by risk-management policy or regulation or by
rate-of-growth objectives in combination with the sheer
magnitude of the funds to be invested. As a result, institutional
investors do not represent a good source of equity funds for small
to medium-size exploration and mining companies.
Even general public investors, who leverage their portfolios
using margin loans, are constrained by the banks to select shares
from the benchmark S&P/ASX 300 index.
92
It is clear that small to medium-size enterprises (SMEs) are at
a disadvantage because their low capitalisation falls well below
that necessary to create portfolio critical mass, even though
during resource booms they can display very high levels of
growth and rates of return.
Innovative investment vehicles for the resources
industry
It is possible to achieve critical capitalisation for inclusion in an
appropriate index by aggregating the value of a number of the
shares of small and medium size companies using innovative
investment vehicles, such as specialised listed investment
companies (LICs). Such a strategy can make them meaningful
investment targets for large institutions.
The concept of LICs raising equity funds for investment in
diversified portfolios of shares, debt securities, property and
other assets is not new. Yet, Australian LICs have traditionally
been small compared with those in the UK and USA. There has
recently been significant growth both overseas and in Australia
in LICs of various sizes specialising in resources stocks.
Fiscal incentives
There has been significant political debate in many resources-rich
countries, including Australia, about the fiscal treatment of small
and medium size companies.
From time to time, this results in government policy makers
introducing specific fiscal incentives for this sector. Two notable
examples are:
• the Canadian ‘flow-through’ shares, and
• the Australian pooled development funds (PDFs).
A flow-through share scheme has been in place in Canada
since 1983. It has allowed deduction of 100 per cent (enhanced
to 115 per cent in 2000) of eligible exploration expenses from
the taxable income of private investors. This has assisted Canada
to become the world’s largest mineral explorer for much of this
period. In 2003, for example, annual mineral exploration in
Canada amounted to an estimated US$ 488 million.
Even though there has been considerable political lobbying in
the past two decades, the Australian government has not pursued
such a scheme. This is presumably because a similar scheme
operating in the boom of the late 1960s and early 1970s was
open to abuse.
The Australian government has, however, allowed the
establishment of pooled development funds (PDFs) to provide
equity capital for eligible activities of Australian SMEs under
stringent compliance rules. The Pooled Developed Funds Act
1992 requires that a PDF must invest 65 per cent of the capital it
raises within five years. There must be a minimum of ten per
cent equity in new Australian companies with total assets less
than $50 million. This initiative is designed to establish an
eligible business or substantially expand existing capacity or
markets.
The Australian Government taxes PDFs at a concessionary
rate. Their taxable income has the following components:
• SME income, which is taxed at 15 per cent (instead of 30 per
cent); and
• unregulated (ie non-SME) income, which is taxed at 25 per
cent as an incentive for PDFs to invest uncommitted funds in
SMEs instead of in interest-bearing securities.
In addition, capital gains on disposal of PDF shares and PDF
dividends are tax-exempt.
One notable recent example of a PDF is the Lion Selection
Group Ltd. Its strategy is to invest in precious and base metals
projects, which are close to development or at the advanced
exploration stage. It seeks also to invest:
Australian Mineral Economics

• $5 to $10 million each in ten to 15 SMEs with outstanding
people, value and growth potential;
• half if its funds in Australia and the other half in Africa and
South-East Asia; and
• no more than 30 per cent of its total capital in any single
project.
Etheridge and Uttley (2003) have proposed the ‘dedicated drill
fund’ concept as a highly specialised form of PDF. They argue
that Australian junior company exploration programs have been
unnecessarily long and protracted because of their struggle to
secure drilling funds. Yet, the first mineralised drilling
intersection is usually when most value is added to an
exploration/mining project as reflected in rapidly rising share
prices. Good examples of this may be found in the dramatic rise
in the share prices of Jubilee Mines NL or of Minotaur
Resources Ltd following their discovery of the Cosmos nickel
sulfides in Western Australia and of the Prominent Hill
copper-gold deposit in South Australia respectively.
In their subsequent argument, Etheridge and Uttley advocate
the establishment of dedicated ‘drill funds’ – spending in excess
of 80 per cent of the funds raised on drill-testing robust targets.
The concept envisages a major company partnering the fund with
an option to acquire between 50 and 60 per cent of high-value
discoveries. While such ‘drill funds’ remain at the proposal stage,
the concept may deserve serious consideration from government.
Joint venture farm-outs
A joint venture (JV) is as a contractual arrangement where two or
more parties cooperate to enhance the potential performance of a
project that no one of them would develop on their own. Joint
ventures include two stages:
• A farm-in/farm-out stage, where the ‘farming in’ party
progressively acquires a predetermined percentage of the
equity in a project from the diluting ‘farming out’ party for a
specific consideration, which frequently includes a
commitment to fund exploration or development work. In
this respect as a source of funds, the farm-out stage of a joint
venture is similar to a partial asset sale.
• A joint venture proper stage, which commences after the
joint venture participants reach the desired level of equity
ownership. During this stage participants contribute to the
joint venture’s expenses and share its produce (not profit)
generally in proportion to their equity. As a consequence, the
joint venture ceases to be a source of funds for the diluting
company, unless the agreement is ‘geared’ or includes
progressive payments unrelated to dilution of equity.
Specialty finance (royalty) companies
Specialty finance (royalty) companies provide funds for
acquisition, development or expansion mainly of operating gold
mines or advanced projects in exchange for an appropriate gold
royalty on production. This source of funding differs from gold
loans (discussed below in the debt sources of funds section) in
that the financiers share in the risk of the project.
THE COST OF EQUITY: BALANCING RISK AND
RETURN
The utility theory would suggest that ‘economically rational’
investors would select among the various opportunities open to
them the course of action that maximises their utilities
(Hirshleifer, 1980). To the extent that the magnitude of
individuals’ utilities is, among other things (see Chapter 10), a
function of their risk tolerance, one could say that investors will
tend to maximise their wealth, while minimising their risk
Australian Mineral Economics
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
exposure, but that, depending on their degree of ‘risk-aversion’,
will (within limits) be willing to trade risk for higher returns.
Thus, a rational investor would not shift money from riskless
Government Bonds (returning the risk-free rate of return (RF))
to a risky project unless he or she receives a suitable risk
premium for bearing the additional risk.
The risk of any individual investment is characterised by two
components:
• idiosyncratic risk, which is unsystematic and unique and
depends on the characteristics of the specific investment and
which can be diversified away (see Figure 9.6) by
constructing a portfolio of a reasonable number of
investments (15 to 20), the return of which is ideally poorly
correlated; and
• systematic or market risk, which depends on broader
movements in the economy at large and which is
non-diversifiable away by portfolio effects (see Figure 9.6).
FIG 9.6 - Diversified portfolio effect. (Source: Deer, 1987.)
Trench (2002) points out how the performance of a
nickel-producing company is correlated with demand derived
from the steel industry, which in turn is one of the best indicators
of aggregate economic activity. Its risk is therefore mainly
systematic. By contrast, the success of a nickel exploration
company and a possible new nickel mine development project is
dependent on whether the relevant exploration drill holes are
mineralised or barren, and on the local ground conditions. The
major part of its risk is unique and independent of economic
conditions.
An investor in a diversified market portfolio (ie in a portfolio
including all securities weighted by their respective market
capitalisation, say the All Ordinaries Index) would legitimately
expect to receive a return on the market portfolio (RM)
adequate to compensate for bearing the market or systematic risk
but not any unique risk. Naturally, RM should be greater than the
risk-free return (RF), ie should incorporate a market premium
(RM – RF).
The market portfolio premium has varied over time, with a
tendency to a gradual decrease. For instance, according to
Officer (1989 in IPRT-NSW, 2002) from 1882 up until 1987 the
market risk premium averaged around 7.9 per cent on an
arithmetic mean (or more correctly 6.6 per cent on a geometric
mean). If the average is extended to 1997, these value drop to 7.1
per cent and 5.7 per cent respectively. In post World War Two
times (until 1991) the arithmetic mean has fallen to 6.6 per cent
(Hathaway, 1996 in IPRT-NSW, 2002). A number of recent
surveys display a high level of annual variability, with recent
annual or shorter arithmetic means in the range of three per cent
to 7.1 per cent.
93
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
An average of six per cent is generally used as a general
approximation, even though it may be naive to assume that future
market performance will necessarily follow a linear extension of
the past.
To the extent that the idiosyncratic risk is diversifiable, financial
markets neglect it in determining the return that equity investors
should expect to justify investing or maintaining their funds in
specific securities/projects, also known as the cost of equity (RE).
Different investments within the market portfolio, however,
respond differently to overall economic influences. In some cases
they are sensitive to and amplify general market movements, while
in others they react less than average to them. Investors must be
compensated for this range of variations in the behaviour of
different investments by providing a higher risk premium for
investments that are more volatile than the market portfolio and
vice versa. This adjustment is achieved through the use of a
β (beta) index reflecting how the return on the project is sensitive
to and would amplify or abate general market movements. Thus,
the applicable risk premium becomes β*(RM – RF), where a β>1
denotes sensitivity to market.
The capital asset pricing model (CAPM) captures this
relationship between risk and the related cost of equity funds:
Cost of equity (RE) = RF + β(RM - RF)
where:
RE is return on equity
RF is risk-free rate of return
RM is return on the diversified market portfolio
β is index of the sensitivity of a security returns to market
So if the risk-free rate of interest (RF) is five per cent and the
beta (β) index of a specific exploration company is 1.35, ie
reasonably sensitive to market. Assuming an average market risk
premium of six per cent the cost of equity would be:
Cost of equity (RE) = 5% + 1.35 * 6% = 13.1%
SOURCES OF DEBT
Some general considerations
In raising debt funds either for their operations or for new
developments, or both, companies have access to essentially two
types of lending:
• corporate finance, where a bank lends to the company as a
whole and has recourse to secure its debt on the company’s
total assets and on the company’s cash flows to service its
debt; and
• project finance, where the capital investment involved will
be repaid and serviced only by the cash flows generated by
the project with no (in reality generally limited) recourse on
all the other company’s assets.
Irrespective of its type, debt can be characterised by its:
• Term, either short term (ie with maturity of less than
12 months) or long term (ie with maturity of more than
12 months). The terms of loans should ideally match the life
of the investments they are funding.
• Degree of security, whereby loans can either be secured,
senior or un-subordinated (ie guaranteed by specific assets or
by a floating claim against the borrowing firm’s assets) or
unsecured or subordinated.
• Marketability, ie whether the relevant debt instruments can
be traded on secondary capital markets, where, by contrast
with primary markets, no new funds are raised.
94
• Type of interest rate, whether fixed or variable. Nowadays,
swaps are commonly used to convert variable rate to fixed
rate loans.
From a company’s point of view, debt finance has a number of
advantages. Firstly, funds are available flexibly and when
actually needed. Secondly, the transaction cost of establishing a
loan are lower than those of equity and, because of the
tax-deductibility of interest expenses, debt leverages returns on
shareholders’ equity. Finally, contrary to the providers of equity,
lenders do not acquire ownership of and control over the
borrowing firm, thus there is no dilution of ownership.
There are, however, a number of disadvantages including the
fact that, as interest expenses are unrelated to fluctuating profit
levels, higher levels of debt bring about additional ‘financial
risk’. Also, floating security over a company’s assets extends
financial risk to projects other than the one being funded with
debt. Even in project finance, restrictive covenants may limit the
capacity to use other company assets as security to raise funds
for new projects.
While senior lenders have no formal control over the company
as long as it regularly services its debt, they can acquire a critical
influence on its affairs if there are liquidity problems.
To make use of debt, a company must either have currently
positive net cash flows or expect to become cash-flow-positive in
a sustainable way in the foreseeable future. Small to
medium-size exploration companies, without the backing of a
profitable operation are not cash-flow-positive and consequently
cannot service debt. They must therefore rely entirely on equity
to fund their operations, even though it is complex and expensive
to raise. This is the case at least until they make a discovery and
can secure project finance by convincingly establishing project
feasibility. Major integrated mining houses, by contrast, with
strong, diversified balance sheets and large annual cash flows,
have little difficulty in raising debt funds both on their balance
sheet (eg conventional loans, bonds, notes and debentures) or
project-backed. But even exploration subsidiaries of major
integrated mining houses display the highest level of investment
in exploration at times of boom when new equity is easy to raise
in the capital markets.
Long-term debt
Companies use long-term debt for mine construction and
development and for ongoing corporate funding needs. In most
cases, lenders ensure that it is secured by a senior claim on the
firm’s assets.
Long-term debt can be either marketable or non-marketable. It
includes:
• Long-term commercial bank loans, mostly at a variable-rate,
fully drawn advances with terms of one to ten years. Variable
interest rates are based on the government bond rate plus a
margin between 1.5 per cent and four per cent depending on
the lender’s level of perceived risk. Fixed-rate bank loans, by
contrast, tend to have shorter terms of one to five years. In
both cases interest is generally calculated on a daily basis and
charged monthly in arrears. Loans are mostly on an
interest-only basis with balloon principal repayments. On rare
occasions a schedule of progressive principal repayments
(credit foncier typical of the mortgage loans frequently used
by property developers) applies.
Although banks are reluctant to grant long-term debt at a
fixed rate of interest, it is possible to utilise a swap
agreement to achieve the same result as if the loan had been
issued on a fixed rate. While no principal changes hands, if
in any period the variable rate rises above the agreed swap
rate, then the merchant bank providing the swap will remit
the difference to the borrower. Swaps are desirable because
Australian Mineral Economics

they make a company’s liabilities more predictable thus
reducing the perception of financial risk in the eyes of
institutional investors.
• Specific project finance, secured mainly by the fortune of
the project, which is becoming an important source of funds
to the resources industry for mine development.
• Marketable long-term debt papers that are issued directly
to lenders and traded on secondary markets.
• Debentures, which are long-term (one to five years),
fixed-interest instruments mostly written by finance
companies, secured by specific assets or floating charge over
the company’s assets. Debentures require the issuing of a
prospectus and ASX listing and are therefore expensive.
Furthermore, the trust deed imposes restrictions on further
senior debt and on the company’s level of total liabilities. To
obviate these difficulties, companies often combine a bank
loan with a swap instead to achieve long-term fixed interest.
As a consequence, debentures are becoming a less popular
means of raising funds.
• Corporate bonds, issued by large companies, with a credit
rating of AA+ or better. They are generally placed with
private or institutional investors. Hence, there is no need for a
prospectus, making this source of funds cheaper than
debentures. They are generally issued at a fixed interest and
are unsecured. Australian dollar denominated Eurobonds are
sometimes issued on medium to long terms outside Australia.
While their interest rates may be comparatively low, it is
advisable to hedge against exposure to currency risk.
• Unsecured notes, which are similar to debentures but, as the
name implies, they are unsecured. The trust deed is less
restrictive and hence they are more risky, Consequently,
lenders are justified in demanding a higher rate of interest.
• Financial leases, which are normally used to fund purchases
of plant and equipment. The mining company (the lessee)
obtains the right to use the plant and equipment, which
remains the property of the lessor, by paying rental with no
immediate requirement for significant capital outflows. There
may or may not be an opportunity to purchase the equipment
at expiry of the lease. In the past it was possible to structure
the lease agreement in a manner that did not generate a
liability in the lessee’s balance sheet. This arrangement is
referred to as an operating lease. Lenders generally recognise
that lease agreements generate a definite liability for the
lessee. They are generally recognised in balance sheets as a
financial lease. While there are a number of desirable aspects
to sourcing funding through leasing, the implicit interest rate
may be higher than that of an equivalent loan. An effect
similar to leasing is achieved by contracting out aspects of
mine development or operations to a contractor that supplies
the use of the necessary plant and equipment.
• Commodity (gold)/derivative loans and advance sales
contracts. Companies have used gold loans for construction
and development of gold mines when a very high gold price
contango (see Chapter 7) and low gold leasing rates made this
approach extremely cheap, even though the latter was not
tax-deductible in spite of being a form of interest. The bank
would buy gold and lend it to the company. The company
would then sell this gold to finance the development of the
project, pledging to deliver gold to the bank at a future date
from its production. Commodity/derivatives linked facilities
have become less frequent due to lower contangos. More
recently as it will be seen, merchant banks have made it a
requirement of project finance packages for the development
of nickel and base metal mines for the proponents to sell
forward a significant proportion of their production while the
loan is outstanding. In some cases customers (off-take parties)
have contributed to the development funding of projects to
secure supplies for their smelters, for example, Inco financing
Australian Mineral Economics
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
the Emily Ann nickel project in the Southern Goldfields
region of Western Australia (Rothschild and Son (Australia)
Limited, 2000) and Jinchuan financing the Sally Malay nickel
project in the Kimberley region. In some cases, to support
desirable developments, customers have actually bought and
paid for future production in advance. This practice is known
as customer finance.
Short-term debt
Short-term borrowing – that is debt instruments with maturity of
less than 12 months – is the main tool for day-to-day liquidity
and operational cash management. This is because the
operational cash flows of many mining operations are seldom
smoothly distributed over time and accurately predictable and the
consequences of lack of liquidity at times of peak demand on the
company’s cash are potentially dire. There are a number of
short-term debt facilities, which, aside from trade credit (the
cheapest form of borrowing) include:
• overdraft accounts;
• loans secured by the inventories or by the accounts receivable
(factoring) and similar very short-term instruments;
• bridging finance; and
• marketable debt papers including promissory notes, bills of
exchange, bank bills (often as revolving facilities) and non-bank
bills, all of which are sold at a discount to their face value.
HYBRIDS BETWEEN EQUITY AND DEBT
There are a number of hybrid financial securities that display the
characteristics of both equity and debt.
These include preference shares, which are legally equity but
which financially, display more the characteristics of debt. They
have preference over ordinary shares in terms of receiving
dividends and capital repayments. Dividends are often fixed and in
many ways resemble interest payments. Generally, they can be
converted into ordinary shares at any time or at the end of a
specified term. In some cases, the contributed capital can be
redeemed. This is not dissimilar from the repayment of a loan
principal, making this type of shares very similar to a
fixed-interest loan. The main difference is that preference shares
are less secure, ranking after other creditors in case of liquidation,
that the quasi-interest dividends are not deductible for the purpose
of assessing income tax and that, in some cases, they have a right
to participating with ordinary shares in profit distributions.
They also include unsecured convertible notes that can be
converted into ordinary shares or redeemed at maturity. From a
legal point of view, these are initially treated as debt, but
ultimately after conversion into shares they become equity. As
convertible notes generally have definite terms and fixed rates of
interest, they are effectively equivalent to a fixed-term loan plus
an option. The value of this option makes it possible for
companies to issue convertible notes at a lower level of interest
than would have applied to a corresponding conventional
fixed-interest term loan.
PROJECT FINANCE
Some introductory considerations
A standard definition of project finance is:
Financing of project development based on a
financial structure with no, or more often limited,
recourse on the corporate assets of the sponsoring
company, where project debt and equity used to
finance the project are secured only by the project
assets and serviced and repaid from the project
cash flows.
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CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
Few, if any, current project finance deals are truly no-recourse
as the relevant arrangements may include significant restrictive
covenants on further encumbering company assets without the
consent of the project lenders. This may entail limits being
placed on further borrowings, on the issuing of shares and on the
amount of dividends to be paid, etc.
Companies negotiate most current project finance (PF)
arrangements to share risks, under-pinning financial structures to
shift some, but not all, risk from the corporation to the lender.
Lenders may receive some reassurance from a requirement for
borrowers to provide project completion guarantees backed by
equity (hurt money) and to maintain specific financial ratios
while the loans are outstanding.
Much initial project finance focused on large projects and
companies but more recently small to medium-size enterprise
(SME) promoters have become more sophisticated and
persuasive in their approaches to merchant banks. Project finance
arrangements often come into play when venture capitalists
realise their gains by vending into an initial public offering or to
other equity investors.
Merchant banks have also become more effective in
identifying and valuing potential assets and growth opportunities
irrespective of the influence of their corporate owners. In this
context they have gone up-stream and taken a project facilitation
role by:
• locating initial sources of venture capital,
• identifying and introducing potential joint venture participants,
and
• protecting juniors from potential takeovers.
There have even been instances of merchant banks providing
minor participation funds prior to finalisation of feasibility
studies, subject to risk-reward considerations and repayment at
the earliest opportunity. The rewards for successful relationship
banking with project sponsors may go beyond the project finance
fees by securing additional business, such as supporting a
possible listing, hedging arrangements and margins and foreign
exchange transactions.
As with equity, the availability of project finance is somewhat
cyclical and dependent on market sentiment and commodity booms.
Whether funds are available depends on the strength of the
project and on a detailed and robust (bankable) feasibility study.
Lead advisor banks generally have specialised mining analysis
departments, which will carry out thorough technical and
discounted cash flow modelling and evaluation of the project and
risk analysis on a 100 per cent equity basis prior to project
finance negotiations.
Banks generally require free access to and time to digest
additional information particularly about:
• the grade and size of the resources and reserves and related
models and on the prospectivity of the surrounding
tenements;
• the technical feasibility of the mining design proposed and
the realism of the related capital and operating cost
estimates;
• the potential position of the proposed operation on the supply
(cost) curve for its commodity;
• the reputation, experience and track record of the company
management and its consultants in managing similar
developments and operations;
• how sensitive the financial performance of the project would
be to variations in the value of its main inputs and to changes
in the mining design adopted; and
• the realism of various schedules of production under
different scenarios that must display a sufficiently long tail of
ore beyond the life of the PF loans.
96
In carrying out due diligence, banks review source data,
construct their own models and project cash flows focusing
mainly on the ‘downside’ of the project. They tend to disregard
sponsor tendencies to focus primarily on the ‘upside.’
If a project’s proponents are to be successful in obtaining
project finance, the project must satisfy a number of financial
ratios tests, the most critical of which (Amos, 1995, p 15) are:
• the project life ratio, ie the net present value (NPV) of the
operating surplus for the life of the project at the end of the
period divided by the loan principal outstanding at the
beginning of the period; and
• the loan life ratio, ie the NPV of the operating surplus for
the life of the loan at the end of the period divided by the
loan principal outstanding at the beginning of the period.
Acceptable values for these ratios depend on the commodity,
location, sovereign risk, the size of the project and the individual
bank’s strategic objectives (Amos, 1995).
The final ratio of importance is the debt service ratio of which
there are a number of formulations. Generally banks require a
minimum cash debt cover ratio of 1.5, calculated as follows:
(Annual cash flow + interest expenses + principal
repayments) / (interest expenses + principal repayments)
This measure differs from the corresponding and frequently
quoted interest cover ratio based on financial accounting accrual
rather than cash figures, calculated as follows:
(Earnings before interest and tax) / interest expenses
Project finance packages are project specific, highly structured
and take into account tax implications. They are generally
syndicated packages of different loan facilities provided by different
lenders and coordinated by a lead merchant bank. Packages offer
flexibility to match the varying funding needs of different stages of
the project development, commissioning and initial operations over
time. As a result they are typically a mix of short- and long-term,
floating or fixed rate loans with different principal repayment
profiles, currency denominations and related details.
Banks tailor the terms and repayment schedules to fit
prospective, but conservatively estimated, cash flows from the
project. Naturally, the project must have the capacity to provide
an expected rate of return sufficient both to ensure that the
borrowing is adequately secure and serviced as well providing a
reasonable return on equity funds. Thus, determination of an
appropriate discount rate to be used in the evaluation may be a
challenge. In packages requiring a substantial proportion of
forward sales, the discount rate to be used must be reduced
accordingly to recognise the fact the major source of risk, ie
commodity price volatility, has been hedged.
From a lender’s risk-minimisation point of view payout
periods and repayment profiles must be as short as possible
without hindering the success of the project. This may mean that
debt has to be serviced preferentially to equity.
Sponsors often push for as much debt as possible, while merchant
banks usually insist on as much equity (‘hurt money’) as possible to
underpin some of the risks. Nevertheless, project finance loans
between 75 per cent and 85 per cent of total development funds
have been common in recent mineral boom times.
Risk underpinning
In the majority of recent project finance loans, banks have
retained some recourse on the sponsor’s balance sheet, at least
until physical completion of the project. After this point their
interests are secured mainly by the fortune of the project.
Australian Mineral Economics

Banks insist on stringent specifications regarding physical
completion and acceptable pre-defined operational performance.
They insist that the sponsor should bear the risk of achieving the
relevant milestones on time and on budget.
Junior sponsors must be able to raise adequate equity capital to
cover feasibility costs and possible project cost over-runs, if they
are to qualify for project finance. Sponsors may react by
transferring some of this risk to contractors through turn-key
contracts, but this may add significantly to project costs. Even
after successful completion tests, banks may insist on stringent
risk-management measures being in place before lessening or
relinquishing recourse to sponsors.
When the project has passed the physical completion and
operational performance tests, the banks become partially or
fully exposed to a variety of major risks including those relating
to whether:
• The operations proceed according to plan, with projected
production schedules being achieved and ore reserves and
grade estimates being reconciled with the metal produced.
• Producers sell the mine’s output at the estimated prices,
keeping in mind the issue of commodity price volatility and
that the lead time to production may have been between two
and four years. Banks may make it a condition that some of
this marketing risk be mitigated by an appropriate level of
hedging while the loans are in place.
• Management is competent and operates the project
successfully.
• There is compliance with the necessary legal conditions to
secure and maintain valid title, and other statutory and
environmental requirements. There may also be exposure to
some sovereign risk, which in its mildest form may express
itself as bearable changes in the regulatory and fiscal regime
affecting returns over time, while at the limit may culminate
in expropriation of the project.
Rather than being a true non-recourse source of funding,
project finance may be more of a risk-sharing mechanism. For it
to be successful and result in lower cost of funds, the relevant
arrangements should convey various sources of risk to those
parties better equipped to bear it. The matrix suggested by Deer
(1987) illustrates the process of risk attribution well. A version of
this appears in Table 9.2.
If a project is large and reasonably secure, the lead bank may
decide either to unbundle or accept (or securitise) the project
credit risk, or both, so that syndicate investors can raise money
by selling secured bonds domestically or source funds from
low-interest euromarkets and other global capital markets.
TABLE 9.2
Project-finance risk-sharing. (Source: Deer, 1987.)
Type of risk Banks Borne by Other
borrower
Reserves X companies in Australia seldom exceed half of total assets.
(subject to audit)
Completion X or X proportion of debt in the financial structure of a company can
(eg contractors)
Operating X X
(following (depending on
completion test) conditions)
Marketing X X or X of a mining company’s assets in case of a liquidation fire sale may
(limited) (eg customers)
Management X for a while with increasing debt, then plateau and start rising rapidly
Legal X again when suboptimal levels of debt are reached.
Force majeure X X
(limited)
Australian Mineral Economics
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
THE FINANCIAL STRUCTURE OF MINING
COMPANIES
Cost of debt, financial leverage and financial risk
A prudent amount of secured borrowing by credit-worthy
companies is inherently significantly cheaper than the cost of equity.
The cost of debt (RD) is further reduced after tax as the
relevant interest expenses before tax (I) are deductible in
determining the company’s assessable income. The result is that
the rate of return on equity (RoE) generated by a project funded
with debt is higher than that from a project funded entirely with
equity. This effect is known as financial leverage. On a financial
accounting accrual basis, gearing (borrowing) will leverage
return on equity on a period-by-period basis by a factor of:
PBIT/(PBIT – I)
The profit before interest and tax (PBIT) must be greater than
the interest expenses after tax (I*(1-t)), where t is the tax rate.
Conversely, on a cash basis the overall internal rate of return
(IRR) of a project will also significantly increase with gearing,
subject to the condition that in any period PBIT plus depreciation
plus the difference between the opening and closing balance of all
other balance sheet items over the period must be greater than the
corresponding after-tax interest expenses (I*(1-t)) for the period.
Hence, in theory at least, it would be in the shareholders’ interest
to make use of as much debt as prudently possible. One might
expect to find relatively high levels of debt in the balance sheet of
most mining companies. However, this does not appear to be the
case in practice because borrowing introduces a new dimension of
financial risk, particularly if PBIT is close to I*(1-t).
Financial structure of mining companies
The average amount of debt on total assets [D/(D + E)] differs
widely from industry to industry. However, the risk inherent in
the resources sector, when compared with the additional
financial risk brought about by increasing levels of borrowing,
seems to act as a disincentives to borrow. Because of their high
level of risk, exploration companies have generally low or zero
levels of debt, while mining companies, on average, have only
moderate debt levels.
In surveying 30 large global mining companies,
PricewaterhouseCoopers (2004) revealed that on average their
debt:equity ratio is relatively low at 28.4 per cent, ie that only
22.2 per cent of total funds employed were constituted by debt.
This does not mean that individual mining projects may not
display significantly higher or lower levels of debt. Indeed, the
level of debt used is not constant over time. It is generally high at
the start of project developments. As already noted, project
finance packages for individual developments in Australia often
cover between 75 per cent to 85 per cent of total funds, but are
subject to repayment in the early stages of production.
Overall ongoing levels of the corporate debt of mining
This behaviour is consistent with the ‘traditional’ view that the
increase with beneficial leverage effects until both shareholders and
lenders become anxious about the increasing financial risk and
expect rapidly increasing returns to compensate for it. Even secured
lenders become anxious because they know that the realisable value
be much lower than its book value. As Figure 9.7 shows, the
weighted average cost of capital (WACC or RC) after-tax will fall
Modigliani and Miller (1963), by contrast, maintained that
theoretically, in frictionless capital markets, the risk-adjusted
97
CHAPTER 9: AN INTRODUCTION TO MINERAL FINANCE
FIG 9. 7 - Optimising the after-tax weighted average corporate cost
of capital traditional view.
return expected by both shareholders and lenders would
gradually adjust upwards as the level of debt increases and that,
for this reason, in the final analysis the actual level of debt used
to fund a project/company should not matter.
Calculating the after-tax WACC, ie:
WACC = (D/D+E) * RD * (1- t) + (E/D+E) * RE
is a relatively simple matter as the following example illustrates
using the following assumptions:
• cost of equity (RE) = 13.1 per cent,
• cost of debt (RD) = 6.5 per cent,
• tax rate (t) = 30 per cent, and
• debt (D) as a percentage of total funds = D/(D + E) = 40 per cent.
After-tax WACC = 6.5% * 0.4 * (1- 0.3) + 13.1% * 0.6 = 9.68%
Note how the after-tax weighted average cost of capital at 9.68
per cent, is considerably lower than the corresponding cost of
equity at 13.1 per cent.
In Chapter 10 it will be argued that the before-tax WACC is a
suitable discount rate if project risk is similar to that of the firm as a
whole and the project is going to be funded with a mixture of debt
and equity. The before-tax WACC should be used as the discount
rate instead of the after-tax WACC, because the DCF model will
deduct the interest expenses before calculating the taxable income
and related tax, hence the tax shield due to the deductibility of
interest expenses is incorporated in the model output.
In the early stages of project evaluation, however, it is
customary to assess the financial robustness of a project by
assuming 100 per cent equity funding and using the cost of equity
(RE) as the discount rate, particularly if the project is to be funded
primarily with share issues and/or from retained earnings.
CONCLUSIONS
1. Financial objectives and management of exploration and
mining companies differs from that of other sectors of the
economy only in so far that their resources and reserves are
depleting, they are capital-intensive, and that, particularly
exploration, is very dependent on the availability and cost
of raising equity funds.
2. In spite of a high number of IPOs in times of boom, the
mining sector is becoming a less important component of
the ASX capitalisation because the amounts raised (ie $2.5
to $6 million) and capitalisation of exploration and mining
companies is relatively low.
98
3. As a consequence only a few resources companies qualify
for inclusion in the main S&P/ASX 300 index and large,
index-using institutional investors tend not to be interested
in them.
4. Mergers, takeovers, listed investment companies (LICs) and
PDFs are effective strategies to overcome this handicap and
tap into institutional funds.
5. Different financial structures are appropriate to different
project stages:
a. on account of its risk, exploration up to feasibility is
funded primarily by equity;
b. development and construction make use of significant
levels of debt mainly in the form of project finance, but
banks will require early repayments and risk mitigation
by way of some equity to guarantee project completion
and possible cost over-runs; and
c. ongoing operations are funded with a lower (generally
less than 50 per cent), appropriate and stable proportion
of debt.
6. Use of an appropriate but prudent level of debt in the
financial structure of a project will increase/leverage the
return on the equity invested in the project (RoE or IRR)
because of the tax deductibility of interest expenses.
7. Increased debt will however increase financial risk and
consequently the after-tax WACC of the firm.
8. No-recourse or limited recourse project finance is becoming
the prevalent way of funding new mine developments, with
lead merchant banks putting together flexible, generally
syndicated, packages of loans to best match the timing and
nature of the project funding needs and to attribute risk to the
parties best equipped to manage it efficiently and effectively.
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Australian Mineral Economics

Mineral Project Evaluation — An Introduction
Pietro Guj
What is it Worth? – Types and Uses of Financial Valuations
Income-Based Valuations and Discounted Cash Flow (DCF) Models
Modelling Debt and Financial Leverage
Comparison of Mutually Exclusive Projects with Different Lives
Inherent Weaknesses and Common Traps in DCF Analysis
Identifying and Quantifying Financial Risk: Expected Value, Sensitivity and Scenario Analyses
Probabilistic Models and Financial Simulations
WHAT IS IT WORTH? – TYPES AND USES OF
FINANCIAL VALUATIONS
General issues
The type of financial valuation methodology used for a mineral/
mining project depends on the stage of the project in the mining
cycle. Valuing an early or advanced exploration project presents
very different challenges, from a development project at the
pre-feasibility or feasibility study stage to the evaluation of an
established operating mine.
The most suitable methodology will also depend on the
intended use of the valuation. While an investor is interested in
the potential financial performance of a project and return on his
or her equity over its entire life, banks may only be concerned
with the capacity of a project’s cash flows to service the interest
and repay the loan principal over the early years of the project
life while debt is outstanding. Banks are essentially unconcerned
if after the loan has been repaid the project becomes unviable.
Government on the other hand, is concerned with the
economic performance of a project. This encompasses both
monetary values and socio-economic measures of benefit, many
of which are non-monetary. This type of evaluation may be of
critical importance to a company seeking government approval
of a project, if its possible development proves politically
controversial with sections of the community or specific
stakeholders or pressure groups.
Setting aside for the moment the complex subject of how to
determine the broader economic value of a project (a process
sometimes involving econometric models, cost-benefit analysis
and input-output and impact matrices), financial evaluations fall
essentially into three distinct categories. Lawrence (2001, p 115)
describes these as:
• market-based,
• cost-based, and
• income-based.
Australian Mineral Economics
CHAPTER 10
The first two approaches are more frequently applied at the
exploration stages, the last after mineral resources have been
indicated and some initial concept of how they can be developed
and mined formulated and costed in a preliminary way.
There has been major development and standardisation in the
field of project evaluation since 1990. The adoption of the
Australasian Code for Reporting of Identified Mineral Resources
and Ore Reserves (JORC code) in 1993, and of the Code and
Guidelines for Assessment and Valuation of Mineral Assets and
Mineral Securities for Independent Expert Reports (VALMIN
code) in 1995, were major milestones. There have been similar
developments in other major mining countries such as the USA,
Canada and South Africa that have promoted greater
reasonableness, materiality and transparency in project
evaluation.
This has been accompanied by a more disciplined approach
and greater accountability on the side of corporate governance
and valuers. Bourassa (2001, p 78) provides a useful review of
the international legal requirements and standards for mineral
valuations.
In Australia, while not specifically mandating the use of the
VALMIN code, the Corporation Act 2001 and the Australian
Securities and Investment Commission (ASIC) Act 2001, make
reference to experts’ reports and valuations and there is evidence
that this code is a benchmark for best practice in the compilation
of prospectuses, takeovers and related documentation.
In its listing rules, the Australian Stock Exchange (ASX)
mandates that all reports dealing with resources and reserves
must be drafted in compliance with the JORC code under the
supervision of a ‘competent person.’ While not mandating
compliance with the VALMIN code, it supports its general
principles.
Lawrence (2001) argues that the ‘fair market value’ of
infrequently traded mining projects, does not necessarily equate
to their ‘price’, which may be realised under specific industry or
corporate circumstances. It is fair to say that internationally there
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CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
is still some confusion about the meaning of such terms as ‘fair
market value’, ‘price’, ‘value in exchange’ and ‘value in use’
based on the highest and best use concept.
The VALMIN definition of market value in Australasia is the
estimated amount of money (or the cash equivalent of some other
consideration) for which the mineral asset should change hands
on the valuation date. It must be between a willing buyer and a
willing seller in an arm’s length transaction in which each party
has acted knowledgeably, prudently and without compulsion.
Market and cost-based evaluations
Market and cost-based valuations circumvent the difficulty
inherent in embarking in income-based valuations when a project
is still at the exploration stage and there is considerable scarcity
of critical information and uncertainty about the input factors
essential to reliably modelling its future potential cash flows.
Given the local influence of real estate valuers, market-based
methods are generally favoured in the US to value and compare
essentially very different mineral projects. Lawrence, (2001,
p 123) observes that there is a continuing debate about the
appropriateness of this approach. He subsequently discusses the
benefit and considerable drawbacks of various market-based
approaches, including the ‘comparable sales’, ‘yardsticks’ and
‘joint venture (JV) terms’ methods.
The ‘comparable sales’ and ‘JV terms’ methods have certain
conceptual similarities in that they establish a fair market value
by comparison with:
• consideration that changed hands in recent transactions; or
• with firm joint venture expenditure commitments and other
consideration to farm into a given level of equity in a project;
which are then grossed up to the implicit value for 100 per cent
of the project.
The problem is that comparable transactions are infrequent,
their precise terms generally confidential and they are influenced
by market sentiment at the time of the transaction. Apart from
the fact that no two mining projects are alike, evolving bull or
bear market influences make comparison of values derived at
different times unreliable.
Besides having the above weaknesses, ‘yardsticks’ and
‘transactional rules-of-thumb’, often relating to resources (eg
ounces of gold) in the ground, also suffer from the variety of
differences that inevitably arise between gross and net values of
different transactions, given their different potential profitability
due to differences in grades, recoveries, unit mining and
processing costs, logistics and other factors.
Roscoe (2001) discusses the cost-based approach, and in
particular the Australian ‘multiple of exploration expenditure
(MEE)’ and Canadian ‘appraised value’ methods in a
comprehensive way. He observes that both methods attempt to
determine a fair market value of exploration properties in which
no potentially commercially viable mineral deposit has yet been
discovered. They utilise the amount of past exploration
expenditure and of justifiable further investment in exploration to
test a project’s residual mineral potential as the basis for its
value. In the case of MEE these figures are then adjusted by a
prospectivity enhancement multiple. Roscoe also reviews the
Canadian appraised value method with reference to comparable
exploration property transactions.
As with the market-based approach the validity of these
methods ultimately relies largely on the judgement of ‘expert’,
ideally registered, valuers.
Fundamental or technical evaluation
Irrespective of the approach used, the value of a mineral project
originates from:
100
• its capacity to generate future net income,
• the magnitude and timing of such income, and
• the probability of its realisation.
Income-based valuations are often referred to as ‘technical’
or ‘fundamental’ valuations. This is because they form the basis
from which a market premium (or discount) is added to achieve a
fair market value. The market premium is generally positive in a
bull market and accounts for any strategic, specific corporate or
‘real option’ value, if the project is leveraged to the volatility of
rising demand, commodity prices, exchange rates or other
influencing factors.
Fundamental valuations, generally based on discounted cash
flow (DCF) financial models of projects over their entire lives,
while more objective, may still be biased by their deterministic,
static character and by the weakness inherent in the estimation of
and use of a single discount rate in comparing projects with often
significantly different risk profiles. We explore these issues in
some detail in the following sections that deal with risk analysis
and advanced project evaluation methodologies.
In practice, many of the above valuation methods are not
mutually exclusive and valuers should attempt more than one
approach if they have relevant information to support it at hand.
The introduction of the JORC and VALMIN codes was
accompanied by the publication of a large number of relevant
papers and guidelines, collated in a number of key AusIMM
publications. Prominent among them are the Proceedings of the
VALMIN 1994 and 2001 conferences. Many of the methodologies
discussed in these papers are now in common use in the mining
industry. Torries (1998) provides a useful summary and
description of these methods.
As a consequence the rest of this chapter assumes a degree of
familiarity with basic valuation methodologies. It is dedicated
primarily to considering how to avoid common pitfalls and
discussing recent developments in constructing and interpreting
DCF models of mining projects as an aid in their fundamental
valuation.
INCOME-BASED VALUATIONS AND
DISCOUNTED CASH FLOW (DCF) MODELS
The basic DCF model structure
Investment is the commitment of funds in the expectation of
receiving returns in the future sufficient not only to repay the
investment, but also to generate an acceptable net surplus. Thus,
the overriding corporate objective for the management of a
mining project is to maximise the value-added to the current
owners (shareholders) of the enterprise.
To assess the returns and in particular the value added by a
project one must construct a techno-financial model simulating
its financial performance over its whole life. This model
contains:
• a range of input variables, the value of which must be
estimated or forecast; and
• a series of interactive algorithms, which manipulate the
inputs and generate a range of model outputs or results.
Financial models have three components:
• technical – selection of the most suitable mining method and
design;
• financial – determination of an optimal annual mine
throughput which maximises the value added for the owners;
and
• risk analysis and management – identification and
quantification of:
Australian Mineral Economics
 CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
• market/price risk derived from the volatility of
commodity prices, exchange rates and demand;
• project risk relating to the geological, geotechnical,
metallurgical and engineering characteristics of the
mineral deposit and its preferred mode of development;
and
• financial risk arising from the amount of debt as a
proportion of total funds (gearing) used in funding the
project.
Risk analysis enables decision-makers to determine the firm’s
risk-management policy, ie which elements of risk should be
hedged or insured, contracted out to third parties better suited to
bear them, or borne by the firm.
Financial models underpin three fundamental categories of
decisions:
1. the investment decision – determining the worth of the
project assuming 100 per cent equity funding;
2. the financing decision – determining the optimal level of
gearing to leverage the return to equity holders consistent with
their willingness to bear the additional financial risk; and
3. the portfolio decision – determining the desirability of the
project in light of possible synergies with other existing
corporate assets, ie its capacity to:
• either increase the combined expected returns,
• decrease the combined risk, or
• a combination of both.
It is possible to construct financial models in two ways:
1. Under assumed certainty using single-point, expected
estimates of input variables, which generate single-point
expected model outputs. Single-point models can
determine:
• the inputs to which the project performance is most
sensitive, deserving more in-depth investigation
(sensitivity analysis); and
• the project’s performance under various scenarios, ie
under combinations of likely or extreme input values, to
test the project robustness under pessimistic conditions
or its ‘blue sky’ under optimistic ones.
2. Under probabilistic conditions using probability
distributions (not single-point estimates) of possible input
values, and carrying out Monte Carlo simulations in which
all input variables are sampled randomly and
simultaneously, according to their respective probability of
occurrence, during a large number of model iterations.
Besides the expected value, this approach generates the
surrounding distributions of all possible values for each
model output.
Analysts who construct models under assumptions of certainty
using single-point expected input values often refer to the
exercise and results from it as the project base case.
While DCF models must cover the whole life of the project, it
is an important decision to determine an appropriate period
break-up for the model. Initially most mining projects analysts
usually select a yearly period. Once selected, the timing of
individual cash flows within a period loses its significance.
Analysts typically assume that cash flows take place at the stroke
of midnight of the last day of the period, though infrequently
they assume that they occur mid-period.
Such coarse periods may not be suitable for some models. An
example is the situation where it is necessary to persuade a bank
that a project may generate free cash flows sufficient to service
monthly interest and periodic loan principal repayments. In such
a case analysts should select a monthly or more frequent interval.
Australian Mineral Economics
In simplified models, it is normal to assume that initial
instantaneous investments, say the purchase of an operating
project or a piece of equipment ready for use, occur in year 0.
Year 0 by convention has no duration.
In analysing a project it is possible to build a model in either:
• nominal money terms (also known as historical dollars or
dollars of the day) using figures that incorporate forecast
inflation; or
• real money terms, which do not incorporate the effect of
inflation.
The relationship between real and nominal dollars figures is:
Real dollars = nominal dollars/(1 + inflation rate expressed
in decimals)y
Where y is the number of years between the present (year 0)
and the time when the nominal dollar cash flow will occur.
There are both advantages and disadvantages in the use of
either nominal or real money models. For instance building a
model in real dollars makes estimates of input variables using
today’s dollars more meaningful to planning and cost engineers
and easier to communicate to company decision-makers. Both
groups relate more easily to current prices and costs than to their
future values, which often need to be highly inflated.
Using nominal dollars, by contrast, makes it easier to reconcile
DCF models with forecast financial accounting figures and
related financial ratios and measures of return. Banks often use
these to assess loan applications. It also helps circumvent
difficulties that arise in real dollar DCF models in handling
depreciation and amortisation figures correctly. Although
depreciation of tangible assets and amortisation of intangible
assets are accrual expenses and not cash items, because of their
tax deductibility, they nonetheless influence cash outflow
relating to the tax paid in each period.
Irrespective of whether one uses real or nominal money values,
the result of any DCF analysis should be the same. In practice,
evaluation errors arise because analysts inadvertently mix real
and nominal dollar values.
Finally future inflation can either be estimated on average or
occasionally using a cyclical forecast. The latter approach
generates different inflation rate forecasts at various stages in the
economic cycle and consequently creates complexities when
discounting cash flows to their present value, as individual
nominal discount rates have to be used for each period.
Constructing a simple DCF model of a mine
Project optimisation is an iterative process to determine the
optimal mining method and design, and therefore annual mine
throughput which adds the maximum value for the owners of the
project compatible with the level of risk they are prepared to
bear.
An initial assessment of ore reserves leads to a range of
technically feasible mine methods, mine sizes and related costs.
These in turn determine the related cut-off grade on the basis of
which the initial ore reserves are refined.
Hopefully the outcome is a mining method and rate of
production, which realises economies of scale without creating
excessive operating leverage. The final mine life is heavily
influenced by the need to optimise capital recovery under the
prevailing tax regime.
This task is facilitated by powerful mine modelling and
optimisation software which, given a body of mineralisation,
accurately determines the size and shape of possible mines at
different realisable prices and operating costs.
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CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

While there are no real short cuts to the iterative nature of
mine life optimisation, the process needs to start with an initial
approximation which can be obtained by using Taylor’s
empirical formula (Taylor, 1978):
Mine life in years = 6.5 * (diluted mining reserves in
million tonnes)0.25
This formula, which has been severely criticised on both an
empirical and theoretical basis, was claimed to provide an initial
estimate of the optimal mine life within a band of confidence of
plus or minus 20 per cent irrespective of the mine method or
commodity involved. Contract operations result in faster mine lives
of the order of 75 to 80 per cent of those suggested by the formula.
The structure of a financial DCF model consists of three
groups of cash flows:
• those from operations,
• those from investment activities, and
• those from financing activities.
The sum of these cash flows for a specific project over each
period represents its net cash flow (NCF).
There is a close relationship between the NCF of a project in a
specific period and the sources and applications of funds (cash
flow) statement in the financial accounts of the firm holding the
project for the same period.
Irrespective of whether preliminary or detailed production
schedules have been estimated, the net cash flows from
operations in each period depend on the interplay of:
• the recurrent revenue function (which is quantity sold times
realised price); and
• the recurrent cost function (which is normally quantity times
variable unit cost plus fixed period cost).
The performance of most projects is very sensitive to factors
affecting revenue (eg tonnages, grades, metallurgical recovery,
prices, exchange rates, etc) and to a lesser extent to capital and
recurrent costs.
Consider a company wishing to acquire an operating open cut
gold mine with residual diluted mining reserves of 2 Mt at a
grade of 4 g/t Au for a price of $40 million. The asset can be
depreciated on a straight line over the life of the mine and it is
expected that it will be sold for $10 million after the mine closes.
Taylor’s formula suggests a mine life of five years with annual
ore throughputs of 0.4 Mt per annum. Assuming a waste to ore
ratio of four, removal of waste will average 1.6 Mt per annum.
A simple nominal dollar model of this investment appears in
Table 10.1. This assumes a gold price of US$ 368 per ounce, an
exchange rate of A$ 1 equal US$ 0.70, and gold recovery of
95 per cent.
The operation will produce the following annual quantity of
gold and revenue:
• 48 869 ounces of gold, ie (0.4 Mt or ore * 4 g/t Au * 95 per
cent recovery) / 31.10345; and
• revenue of $25.69 million, ie 48 869 ounces at A$ 525.71 per
ounce.
If we assume mining costs of $2 for each tonne of both ore and
waste moved, with milling cost of $12 per tonne and
administration cost of $2 per tonne of ore treated, the annual
operating and maintenance cost will be:
• $9.60 million (ie 0.4 Mt of ore + 1.6 Mt of waste) * $2 per
tonne mining cost + 0.4 Mt of ore * ($12 per tonne of ore
milling cost + $2 per tonne of ore administration cost).
Some further assumptions are: that inflation will average
three per cent per annum over the life of the mine; that it will
affect both revenue and costs to the same degree; and that cash
flows occur at the end of each yearly period. Both revenue and
cost must be inflated in models using nominal dollars. As a
consequence the annual revenue and cost estimates in year 0
dollars of $25.69 million and $9.60 million respectively must
be multiplied by one plus the inflation rate (ie by 1.03) for each
year in the future becoming (see Table 10.1) $26.46 and 9.89
million respectively in year 1, $27.26 and 10.18 million in year
2 and so on.

TABLE 10.1
A simple nominal dollar model of an operating gold mine.
Year 0 1 2 3 4 5 6 Total
All ($ million)
Sales revenue 26.46 27.26 28.08 28.92 29.79 140.51
Capital gain on salvage 10 10
Less:
Royalty at 2.5% -0.66 -0.68 -0.7 -0.72 -0.74 -3.51
Operating expenditure -9.89 -10.18 -10.49 -10.8 -11.13 -52.5
Depreciation -8 -8 -8 -8 -8 -40
Profit before tax 7.92 8.39 8.88 9.39 9.91 10 54.5
Less tax at 30% -2.37 -2.52 -2.67 -2.82 -2.97 -3 -16.35
Profit after tax 5.54 5.87 6.22 6.57 6.94 7 38.15
Add back depreciation 8 8 8 8 8 40
Net cash flow – NCF -40 13.54 13.87 14.22 14.57 14.94 7 78.15
Discount factor 1 0.8826 0.7790 0.6876 0.6068 0.5356 0.4727
Present value of NCF -40 11.95 10.81 9.78 8.84 8 3.31
Cumulative DCF -40 -28.05 -17.24 -7.46 1.38 9.38 12.69
Net present value at 13.3% discount 12.69
Internal rate of return 24.65%
Discounted pay back period 4
Capital efficiency index 0.32

102 Australian Mineral Economics

 CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
Many mines produce and sell concentrate (eg copper or
lead-zinc concentrate) to a custom smelter rather than metal to a
terminal market such as the London Metal Exchange. Estimating
their revenue, ie their net smelting return (NSR) or value of
concentrate fob mine (free on board - after deducting smelting
and refining charges levied by the custom smelters and the
relevant transport costs) becomes more complex as the terms of
custom smelting are different for various types of concentrates.
For copper concentrates they include:
• a unit deduction of between one and 2.5 per cent;
• a fixed smelting charge per tonne of concentrate;
• a variable refining charge as a function of the contained copper;
• a price participation factor if the LME copper price falls beyond
a neutral zone between US$ 0.70 and 0.90 per pound; and
• credits and penalties for associated metals (eg gold).
More often than not, in preliminary evaluations a percentage
smelter return (eg 75 per cent of the value of the payable copper
contained in the concentrate less transport cost) is used to
simplify calculations.
Detailed revenue and cost engineering estimates are beyond
the scope of this paper, but will be discussed again briefly in the
next chapter.
Project valuations are at a point in time –
discounting cash flows
A modern way of looking at cash flows is to consider them like
commodities, the value of which is determined by two criteria:
timing and risk.
Let us assume that there is no risk attached to future cash
flows. A rational investor would prefer early rather than later
cash flows of equal magnitude because he or she could invest
them and generate interest income. By receiving the cash flows
later the investor would forego interest and incur an ‘opportunity
cost’ equal to the so-called ‘time-value of money’.
To compensate for the opportunity cost, future cash flows are
therefore discounted to their present value at a rate equal to the
return the investor would have derived had he or she invested in
the next best opportunity available.
Rates of discount can be expressed as either decimals or
percentages. In the example described in Table 10.1, there was a
nominal discount rate of 0.133 or 13.3 per cent.
A compounding factor is the sum of one plus a rate of interest
or discount (eg 1 + 0.133 = 1.133 is the compounding factor at
13.3 per cent for one period, 1.1332 for two periods and 1.133t
for t periods). The reciprocal of a compounding factor (eg
1/1.133 = 0.882613 for one year) is the discounting factor for
the same number of periods (eg 1/1.133t for t periods).
Most readers will be familiar with the process of discounting,
which entails determining the present value (PV) of cash flows
to be received or disbursed at various periods (t) in the future by
multiplying them by the discount factor appropriate for the
relevant period (ie 1/(1+discount rate)t ).
To the extent that the corporate objective of an enterprise is
maximising shareholders’ wealth, it seems that the paramount
criterion of value must be the net present value (NPV) or
value-added. NPV is the sum of all the net project cash flows
after discounting them to their present value:
NPV = Σ 0t t
(CFt / (1 + discount rate) )
If the NPV is positive the investment is acceptable because it
adds value after having returned the discount rate on a compound
basis on the capital invested.
Australian Mineral Economics
A net present value of zero means that the investment only
returns the compound rate of discount. Projects with negative
NPVs will consume value and should not attract investment.
In the example described in Table 10.1 the operating mine
adds $12.69 million after paying 13.3 per cent interest on the $40
million investment compound over the five-year life of the mine.
The mine is clearly a good investment.
However, as Figure 10.1 shows, its NPV at discount rates in
excess of 24.65 per cent becomes negative. If the required rate of
return of a company were higher than this, then the project would
be rejected. Thus, whether a project is acceptable or not is a
function of the discount rate that has been applied to it.
Sensitivity of NPV to changes in discount rates
50.00
40.00
NPV at 13.33% discount = $12.69 M
30.00
NPV $ million
20.00
IRR = 24.65%
10.00
0.00
0% 5% 10% 15% 20% 25% 30% 35% 40%
-10.00
NPV = 0
-20.00
Discount rate %
NPV $ million
FIG 10.1 - Sensitivity of NPV to changes in discount rates.
The discount rate at which the NPV becomes zero (ie 24.65
per cent), known as the internal rate of return (IRR), is a
measure of the project return on equity.
Although popular, the IRR has considerable theoretical and
computational difficulties (particularly when the project
generates alternations of positive and negative cash flows).
Analysts should use it, at best, as a subsidiary criterion of value.
In addition, the IRR is a measure of return per dollar invested.
As such, it is of limited use in comparing projects of significantly
different scope. An exhaustive discussion about the pros and
cons of using IRR is beyond the scope of this paper but can be
found in Torries (1998, pp 41-47).
Other subsidiary criteria of value are:
• the capital efficiency index (KE = NPV / PV of CAPEX),
which measures the value added per dollar invested (in the
above example, KE was $0.32 per dollar invested); and
• the pay back period, which represents the time that a project
takes to repay the initial investment. This can be calculated
either as a discounted pay back period (DPBP) period, ie
including interest equal to the compound rate of discount
during the period of payback or on an undiscounted basis. In
the above example the investment is repaid with interest
sometime before the end of the fourth year. To be more
precise a finer (say monthly) time period would have had to
selected to construct the model.
Establishing an appropriate discount rate is a complex and
ambiguous process both from a theoretical and practical point of
view, with there being a serious danger of introducing bias in
evaluations. This issue will be discussed in greater depth later,
while dealing with risk.
For the time being it is sufficient to recognise that firms face
different costs for their:
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CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
• equity, and
• debt capital.
As seen earlier, in Chapter 9, a common tool for determining the
cost of equity (RE) is the capital asset pricing model (or CAPM):
RE = RF + β ∗ (RM – RF)
Where RF is the risk-free rate of interest and β ∗ (RM – RF) is
the risk premium which is the product of the premium on a
balanced ‘market portfolio’ (RM – RF) and of the β index
reflecting the sensitivity of the returns on a specific asset to
movements in the market portfolio.
Use of the cost of equity RE as a discount rate is appropriate if
the DCF model has been constructed under 100 per cent equity
assumptions.
The after-tax cost of debt (RD*(1-t) where t is the tax rate) is
generally lower than that of equity, because loans are in most
instances secured and the related interest expenses are
tax-deductible. This leads to financial leverage, ie to enhanced
returns to equity holders, at least as long as the level of debt in
the funding structure of the firm (ie its debt to equity ratio) does
not rise to a point where it engenders excessive financial risk and
concerns on the side of both the equity and debt providers.
Analysts frequently use the weighted average cost of capital
(WACC) as the basic discount rate in evaluations involving the
use of debt in the funding structure of a project. Its formula is:
WACC = D/(D+E) * RD * (1-t) + E/D+E * RE
where:
D is debt
E is equity
Its before-tax equivalent (ie D/D+E * RD + E/D+E * RE) is
frequently used as the basic discount rate in evaluations
involving the use of debt in the funding structure as the model
will automatically compute the interest tax shield.
Reconciling cash and financial accounting
accrual figures in a DCF model
As their name implies, DCF models deal exclusively with cash
and not with commonly encountered financial accounting figures
typically compiled on an accrual (not cash) basis. Accrual
accounting conventions aim at matching revenue with the related
costs in each period. Erroneous mixtures of cash and non-cash
figures are commonly the source of potentially significant errors in
project evaluations.
Occasionally because of the need to satisfy both financial
accounting and DCF performance criteria, sophisticated models
are constructed in a way that broadly reconciles these two views.
This implies modelling the time lags between ‘recognising’ (ie
accruing) a transaction in the financial accounts and the time
when the relevant cash actually changes hands.
As financial accounts are written in historical or nominal
dollars, it is generally more practical to build this type of model
in nominal dollars.
In steady operations, the differences between the related
opening and closing balances accrued in the balance sheet for
some recurrent items (eg accounts receivable and accounts
payable, inventories, work in progress, annual leave and other
provisions etc) may not be very significant given the general
band of error of preliminary DCF mine models and can therefore
be ignored. However, sometimes significant operational cash
flow may be capitalised in the balance sheet, as for instance in
the case of a large build up of unsold inventories, and may need
to be taken into account in the DCF model.
104
For some other items the lags between the timing of accrual
and cash transactions and the relevant amount may be significant
enough not to be neglected, other than in the most preliminary of
evaluations. For example mineral royalties and taxes accrued in
the first year of operations are payable in quarterly instalments
within 28 days of the end of each quarter. In effect the fourth
quarterly payment is deferred by around four months into each
following year with the last quarterly payment due four months
after the mining operation ceases to produce taxable income.
Given the capital intensive nature of mining and the relatively
long life of its asserts, by far the most significant lags between
cash and accruals occur between lumpy cash out flows relating to
the purchase of capital assets (eg plant and equipment, mining
rights etc) and their recovery over their useful life by way of
annual depreciation and amortisation charges against revenue in
the profit and loss account.
Asset depreciation and amortisation relate to their original,
historical acquisition cost as recorded in the firm’s balance sheet.
Over time the asset register will contain a mixture of historical
values of different years. Furthermore, selected assets are
periodically re-valued while others are kept at their historical
value until fully written off.
While depreciation is not a cash cost (as the cash outflow to
establish the asset occurred in a previous period) it does however,
on account of its deductibility from taxable income, influence the
income tax payable and eventually paid and therefore the project
cash flows. There is a strong case, if one wishes to avoid the
chance of making depreciation related mistakes, for constructing
DCF models in historical or nominal dollars, as there is less
danger of underestimating income tax.
Further complexities in modelling a mining project and in
attempting to reconcile it with the related financial accounting
measures arise because the effective lives allowed by the ATO
for certain mining assets for fiscal purposes are shorter compared
to their actual useful lives in the mining operations and related
depreciation in their financial accounts. As a consequence the
accelerated fiscal rates of depreciation lead to deferral of some
tax liabilities.
Further complexity is created by the degree of directorial
discretion as to whether and when exploration expenditure
should be capitalised or expensed.
Irrespective of whether a model is constructed in real or
nominal dollar terms, its results over the whole life of the mine
must be the same. If this is not the case, there has been a
computational error.
The financial accounting treatment of mineral reserves and
resources in the ground is also an area froth with considerable
complexity and ambiguity. If a company, for instance, discovers
and develops a mining project, the value of the project is
generally recorded in the company’s balance sheet at the
historical cost of its exploration and development. The potential
value of the resources, which have been delineated in the
process, is initially not captured in the balance sheet, because it
is deemed that its realisation is uncertain and cannot be
unambiguously measured. A list of mineral reserves and
resources may, however, be provided in the company annual
report to substantiate the success of its exploration activities.
If on the other hand, another company acquires the same
mining project, its acquisition cost, presumably incorporating the
value of the relevant mineral resources and reserves, will appear
in its balance sheet. The difference between the acquisition cost
and the fair value of identified tangible assets (eg of exploration
and development) represents an intangible asset (a form of
goodwill) called mineral rights. The amortisation of mineral
rights together with the depreciation of tangible assets will be
shown in the profit and loss statement in determining the profit
for the year, but unlike depreciation is generally not
tax-deductible.
Australian Mineral Economics
 CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
Needless to say, these aspects cause difficulties in properly
comparing many conventional financial accounting measures of
value, relying as they do on annual profit, which is a function of
depreciation and amortisation, rather than on cash flows.
This is illustrated in Table 10.2 which provides a comparison
of the annual profits that would be reported by a different owner
of the same mine with a life of five years and with gross annual
revenue of $100 million and recurrent expenses of $60 million
before depreciation, tax and amortisation.
The first column relates to the mine being operated by the
discoverer after a capital investment of $30 million in
exploration and development. The second relates to a company
that acquires the mine at start of production for $140 million. It
is interesting to note how on the basis of a year-by-year
comparison, the discoverer would post a much higher profit than
the acquirer (ie $23.8 versus $1.8 million), even though their
annual cash flow is the same. Clearly just comparing
performance measures based on annual profits in isolation will
not give a potential investor a proper appreciation of the worth of
this project.
MODELLING DEBT AND FINANCIAL LEVERAGE
Returning to our previous DCF example of Table 10.1, let us now
assume that the company only issues ten million shares of $1 at
par to acquire the $40 million operating mine, funding the
remaining $30 million in acquisition cost with a fixed-interest-
rate loan at ten per cent per annum repayable after the end of
year 3.
Also assume, to simplify the exercise, that with good financial
management the opening and closing balances of most accrued
items in the balance sheet would be virtually unchanged, ie that
annual accrual and cash figures for these items are roughly the
same. Under these assumptions, the main focus of the model will
be on the critical items relating to capital assets, the associated
depreciation and salvage and on how to handle loan principal
drawdowns and repayments, fixed interest expenses and retained
earnings.
The DCF model of this mine is constructed in parallel with
and using the corresponding forecast financial accounting
statements, as displayed in Table 10.3. The most convenient
order is first to compile the profit and loss statement using
forecast recurrent revenue and expenditure figures, as they will
accrue in the annual financial accounts of the firm. It is possible
to convert these to the corresponding cash figures in a forecast
sources and applications of funds statement and finally
combine them in the related balance sheet.
TABLE 10.2
Comparing reported profits for ‘discoverer owned and developed’ and acquired mines.
Mine life (years)
Tangible assets: exploration and development
Project acquisition price
Intangible assets: mining rights = price premium paid by acquirer
Gross revenue
Recurrent expenditure
Tax-deductable depreciation
Net operating income before tax
Less tax at 30%
Non-tax-deductable amortisation of mining rights
Net profit after tax
Net cash flow after tax
Australian Mineral Economics
While the individual annual undiscounted profit and net cash
flow figures are vastly different, their cumulative figures at the
end of year 5 (ie $41.85 million) are the same. This would have
been the case even if the company had paid dividends during its
five-year life. In other words matching of annual revenue and
expenses in the accrual accounting financial statements does not
alter the aggregated cash value of the project over its whole life.
As a result, the shareholders’ equity at the end of year 5 at $41.85
million, ie the sum of the retained earnings ($31.85 million) and
the capital originally contributed ($10.00 million), corresponds
to the year 5, closing cash amount of $41.85 million in the
balance sheet.
As already pointed out borrowing will progressively leverage
the expected return on shareholders’ equity (RoE) by a factor of:
PBIT / (PBIT – I)
where PBIT is the annual profit before interest expenses (I) and
taxes (T).
In the previous example, for instance, 75 per cent debt as a
proportion of total funds invested (gearing) generates the
leverage described in Table 10.4, compared to the same project
modelled on a 100 per cent equity funding assumption.
Such a direct comparison, however, is naïve because increases
in debt are accompanied by additional financial risk. It is
therefore inappropriate to compare highly geared and ungeared
projects with significantly different risk characteristics using the
same time and risk-adjusted discount rate.
Empirical evidence suggests that initially, as the level of debt
increases, both providers of equity and debt are not unduly
concerned about the marginally higher financial risk. After all,
shareholders benefit handsomely from leverage effects and the
bank loans are generally secured. However, as gearing increases
shareholders, who bear the ultimate risk of the firm, become
more concerned. Their expectations in term of return on equity
will rise steeply to compensate for the additional risk. Also, as
gearing continues to rise, even the providers of secured debt
become nervous and expect higher interest rates. They fear not
being able to fully realise the value of the assets provided as
collateral in case of a fire sale. As already seen earlier, in
Chapter 9, these expectations for higher returns will soon erode,
and overcome the tax benefits from the lower after-tax cost of
debt vis a vis that of equity.
Discoverer Acquirer
($ million) ($ million)
5 5
30 30
0 140
0 110
100 100
-60 -60
-6 -6
34 34
10.2 -10.2
0 -22
23.8 1.8
29.8 29.8
105
CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

TABLE 10.3
Reconciling a nominal money discounted cash flow model with financial accounting statements.
Year 0 1 2 3 4 5 6 Total
All ($ million)
PROFIT AND LOSS STATEMENT
Sales revenue 26.46 27.26 28.08 28.92 29.79 140.51
Salvage 10.00 10.00
Less
Royalty -0.66 -0.68 -0.70 -0.72 -0.74 -3.51
Operating and maintenance expenditure -9.89 -10.18 -10.49 -10.80 -11.13 -52.50
Depreciation -8.00 -8.00 -8.00 -8.00 -8.00 -40.00
Interest expenses -3 -3 -3
Profit before tax: 4.92 5.39 5.88 9.39 9.91 10.00 45.50
Less tax at 30% -1.47 -1.62 -1.77 -2.82 -2.97 -3.00 -13.65
Net profit after tax: 3.44 3.77 4.12 6.57 6.94 7.00 31.85
NOTE – Fixed nominal annual rate of interest 10.00%
SOURCES AND USES OF CASH (CASH FLOW) STATEMENT
Net cash flow from operations 0.00 11.44 11.77 12.12 14.57 14.94 7.00 71.85
Cash flow – investment activities -40.00
Cash flow – financing activities 30.00 -30.00 0.00
Net project cash flow -10.00 11.44 11.77 12.12 14.57 14.94 7.00 48.15
BALANCE SHEET
Current assets:
Cash 0.00 11.44 23.22 35.33 19.91 34.85 41.85
Fixed assets:
Mine at acquisition cost 40.00 40.00 40.00 40.00 40.00 40.00
Less accumulated depreciation 0.00 -8.00 -16.00 -24.00 -32.00 -40.00
Written down value of mine 40.00 32.00 24.00 16.00 8.00 0.00 0.00
Total assets 40.00 43.44 47.22 51.33 27.91 34.85 41.85
Liabilities: Repaid after the end of year 3
Loan 30.00 30.00 30.00 30.00 30.00
Less loan principal repayments 30.00
Loan principal outstanding 30.00 30.00 30.00 30.00 0.00 0.00 0.00
Shareholders’ equity:
Contributed capital 10.00 10.00 10.00 10.00 10.00 10.00 10.00
Retained earnings 0.00 3.44 7.22 11.33 17.91 24.85 31.85
Total shareholders’ equity 10.00 13.44 17.22 21.33 27.91 34.85 41.85
DISCOUNTED CASH FLOW ANALYSIS
Net cash flow – NCF -10.00 11.44 11.77 12.12 -15.43 14.94 7.00
Discount factor 1 0.882613 0.779005 0.687559 0.606849 0.535612 0.472738
Present value of NCF -10.00 10.10 9.17 8.33 -9.36 8.00 3.31
Cumulative DCF -10.00 0.10 9.27 17.60 8.24 16.24 19.55
NPV at 13.3% 19.55 IRR (%) 97.32 DPBP 1 KE 1.96

It is also important to note (see Table 10.5) that the NPV of the
TABLE 10.4 project at $19.55 million is the same irrespective of whether the
Leverage effects of gearing. model is constructed in nominal or real dollars, provided the
Gearing NPV IRR (%) DPBP KE
nominal dollar cash flow is discounted by the nominal discount
(%) ($ million) (nominal) (Years) ($NPV/Capex) rate of 13.3 per cent and the real model by the corresponding real
rate of ten per cent.
0 12.69 24.65 4 0.32
It could be argued that a more appropriate discount rate for the
75 19.55 97.32 1 1.96 nominal model of Table 10.3 could have been the nominal
before-tax WACC = 0.75*10 per cent + 0.25*13.3 per cent =
10.83 per cent per annum. This would result in an increase in
These issues will be expanded upon later, when introducing NPV from $19.55 million to $21.30 million. As the average
the concept of ‘price of risk’. annual inflation was assumed to be three per cent, this

106 Australian Mineral Economics

 CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

TABLE 10.5
The real dollar model equivalent of a reconciled nominal mine model.
Year 0 1 2 3 4 5 6 Total
All ($ million)
Sales revenue 25.69 25.69 25.69 25.69 25.69 128.47
Salvage 8.37 8.37
Less:
Royalty at 2.5% -0.64 -0.64 -0.64 -0.64 -0.64 -3.21
Operating and maintenance expenses -9.60 -9.60 -9.60 -9.60 -9.60 -48.00
Depreciation -7.77 -7.54 -7.32 -7.11 -6.90 -36.64
Interest expenses -2.91 -2.83 -2.75
Profit before tax 4.77 5.08 5.39 8.34 8.55 8.37 40.51
Less tax at 30% -1.43 -1.52 -1.62 -2.50 -2.57 -2.51 -12.15
Profit after tax 3.34 3.56 3.77 5.84 5.99 5.86 28.36
Add back depreciation 7.77 7.54 7.32 7.11 6.90 36.64
Loan principal drawdown and repayments 30.00 -26.65
Net cash flow – NCF -10.00 11.11 11.10 11.09 -13.71 12.89 5.86 38.34
Real discount factor at (1.133)/(1.03) -1 = 0.1 1 0.9090 0.8264 0.7513 0.6830 0.6209 0.5645
Present value of NCF -10.00 10.10 9.17 8.33 -9.36 8.00 3.31
Cumulative DCF -10.00 0.10 9.27 17.60 8.24 16.24 19.55
NPV at 10.00% 19.55 DPBP 1
Real IRR 91.57% KE 1.96

Note – The nominal internal rate of return (IRR) in Table 10.3 (ie 97.32%) differ from the corresponding real one in Table 10.5 by the inflation factor for
one year, ie:
[(1 + Nominal IRR in decimals) / (1 + Inflation rate in decimals)] − 1 = (1 + 0.9732 ) / (1 + 0.03 ) − 1
= 0.9157 or 91.57%

corresponds to a real before-tax WACC rate of 7.60 per cent,
which, in turn, should have been used to discount the real dollar
cash flows in the model of Table 10.5:
Real rate = [(1 + Nominal rate of discount in decimals) /
(1 + Inflation rate in decimals)] - 1
= [(1 + 0.10825) / (1 + 0.03)] - 1
= 0.07597 or 7.60%
This approach to discounting would be valid if it was the
company policy to maintain an overall constant rate of gearing
and to use its corporate WACC as the rate of discount for project
evaluation irrespective of the funding structure adopted for each
individual project.
One might, on the other hand argue that, in the case of a
single-project company, the cash flows generated in the year
beyond the time of repayment of the loan should not be
discounted at 10.83 per cent nominal or 7.60 per cent real but at
the cost of 100 per cent equity funding, ie 13.3 per cent nominal
or ten per cent real. This approach, which would decrease the
NPV of the project somewhere between $19.55 and $21.30
million, to the author’s knowledge, has not yet been adopted in
relevant financial literature.
The discounted pay back period of one year and capital
efficiency index of 1.96 are also the same in the nominal and real
dollars models. Obtaining the same results, irrespective of the
money terms used, provides confidence that the model
computations are internally consistent and it is a good form of
quality control.
If the straight-line depreciation method, based on the historical
cost of the asset and its useful life, has been adopted, the
financial accounts in successive years will show the same
amount for annual depreciation expenses as in Table 10.3.
Similarly, if no further borrowing takes place, the same figure as
in Table 10.3 will appear in the financial accounts of successive
years for fixed interest expenses. As, by definition, financial
accounts use historical or nominal dollars, these figures are
correctly used in the nominal dollar model.
The same NPV was obtained in the real dollar model because
inputs with constant amounts in the nominal model, such as
depreciation, salvage value, fixed interest expenses and loan
principal repayment, were correctly deflated in Table 10.5 to
reflect their progressively diminishing power of acquisition.
Had this not been the case, the NPV of the real dollar model
would have been different and incorrect. The error of using
nominal depreciation or salvage in real dollar models occurs
frequently. It leads to underestimation of the tax liability and the
overvaluation of projects.
Similar mistakes in the handling of fixed interest expenses and
loan principal repayments, by contrast, severely punish the value
of the project.
Weakness in the handling of the return of working capital at
the end of operations (not included in the above tables) is another
area likely to bias the result of a model. Working capital is
generally estimated in real dollars at the start of the project.
COMPARISON OF MUTUALLY EXCLUSIVE
PROJECTS WITH DIFFERENT LIVES
Project evaluation has to do with choices. Even when one values
a single project using DCF analysis, its acceptability as an
investment depends on the return on the project, exceeding the
alternative of investing the money in the next best alternative, or
at the limit leaving the money in the bank.

Australian Mineral Economics 107

CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

Engineers often have to make a choice between two alternative

Comparison of assets with different lives
pieces of plant or equipment with different capital and operating
costs and expected useful lives. -30000
0% 5% 10% 15% 20%
As an example, we shall consider a decision whether to -35000
purchase one of two pumps, A and B, with four and six years
expected lives and prices of $15 000 and $20 000 respectively. In -40000

Total PV cost $
the first instance, let us assume that their operating cost is the
same. -45000
It is not possible to make a correct choice consistent with one’s
-50000
required discount rate without first making the capital cost of the
two pumps comparable on a per-unit-of-time basis. -55000
This can be done by converting the acquisition costs of the two Pump A
pumps into their annual equivalent values (AEV) and selecting -60000
Pump B
the lower of the two. The AEV is obtained by dividing the capital
expenditure of each pump by the annuity factor for a number of -65000
years equal to its expected life at the required discount rate. Discount rate %
The annuity factor in arrears at an interest rate of i for n years is:
FIG 10.2 - Comparing assets with different lives.
i -n
A n years = [1 –(1 + i) ] / I

which is the same the sum of the individual discount factors for
interest i for year 1, 2, 3…n.
If the required discount is ten per cent, pump A with an annual
equivalent value of $4732 (ie $15 000/3.1699) is more expensive
than B with an AEV of $4592 (ie $20 000/4.3552). If the
operating cost of the two pumps were the same, the investor
would select pump B.
The choice would, change if pump A cost $1500 annually to
operate and pump B $1700 annually, because their respective
total annual equivalent costs would become $6232 for pump A
and $6292 for pump B.
This choice could have been reached by constructing, as in
Table 10.6, the DCF model of repeating the investment in pump
A three times and in pump B twice, thus reaching a comparable
combined life over the same period of 12 years and choosing the
pump with the lower combined present value cost, ie A at -$42
463. As can be seen in Figure 10.2 this choice is a function of the
discount rate selected. At a discount below approximately eight
per cent, pump B would be preferable.
A similar model structure could be used to optimise the lives
of assets, ie to determine when the present value of maintaining
an asset reaches a level that makes replacing it with a new one of
similar capacity the most economic choice. The validity of
maintain or replace models can be ambiguous because is very
dependent on the accuracy of both the historical cost records of
the asset to be replaced and above all the realism of the
performance expectations for the new one.
Lease or buy?
Leasing is an alternative to borrowing funds to purchase a new
capital asset. The lessee acquires the right to use the asset but not
its ownership, which legally remains with the financier (lessor).
There are essentially two types of leases:
• operating leases are cancellable, their terms are shorter than
the effective life of equipment leased, can include
lessor-provided maintenance and they do not create a liability
in the lessee’s balance sheet; and
• finance leases are non-cancellable their terms are longer and
closer (>75 per cent) to the effective life of equipment
leased, transfer risks and benefits of asset from lessor to
lessee and create a liability in lessee’s balance sheet.
Genuine lease rentals for income-generating assets are, like
interest expenses, deductible for tax purposes from a lessee’s
taxable income. However, the relevant asset depreciation is
deductible by the lessor who is the legal owner of the asset but
not by the lessee.
Lessors can also leverage their leases by making significant
use of borrowed funds to fund the necessary assets.
As entering into a lease uses some of the lessee’s capacity to
borrow, the evaluation of a lease from a lessee’s point of view
should use the firm’s cost of debt, unless some specific funding
source is envisaged for individual assets.
Table 10.7, which makes use of an example from Peirson et al
(2002), portrays the comparison between leasing or buying a
capital item, say a large bulldozer, worth $600 000 in year 0,

TABLE 10.6
Comparison of the total cost of assets with different lives.
Year 0 1 2 3 4 5 6 7 8 9 10 11 12
Pump A, lasting four years
Acquisition capital cost -15 000 -15 000 -15 000
Annual operating cost -1500 -1500 -1500 -1500 -1500 -1500 -1500 -1500 -1500 -1500 -1500 -1500
Total cost -15 000 -1500 -1500 -1500 -16 500 -1500 -1500 -1500 -16 500 -1500 -1500 -1500 -1500
Present value of pump A cost -42 463
Pump B, lasting six years
Acquisition capital cost -20 000 -20 000
Annual operating cost -1700 -1700 -1700 -1700 -1700 -1700 -1700 -1700 -1700 -1700 -1700 -1700
Total cost -20 000 -1700 -1700 -1700 -1700 -1700 -21 700 -1700 -1700 -1700 -1700 -1700 -1700
Present value of pump A cost -42 873

108 Australian Mineral Economics


Incremental value analysis of leasing versus buying (after Peirson et al, 2002).
Lease or buy (nominal dollars)
Lessee’s point of view assumptions
Cost of asset ($)
Annual lease rentals ($) 100 000 in advance
Fiscal depreciation life (y)
Tax rate (%)
Real corporate cost of debt (%)
Annual inflation (%)
Nominal corporate cost of debt (%)
Year 0 1
Incremental cost of leasing versus buying
Savings of purchase of asset 600 000
Purchase of asset at end of lease
After-tax salvage of asset
Lease rentals -100 000
Tax savings on lease rentals 30 000
Depreciation tax savings foregone
Net cash flow 530 000
Present value of lease 92 151
which the lessor can fully depreciate over three years. The
annual lease rental is $100 000 in advance for six years and the
nominal corporate cost of debt of the lessee is 7.63 per cent.
The model is constructed on an incremental level, ie it
captures the difference in cost and savings to the lessee between
buying and leasing the asset. Thus in year 0 there is a saving of
$600 000 which the lessee would otherwise had to pay if he/she
had purchased the bulldozer. The tax deductible $100 000 lease
rental in advance also generates a $30 000 tax saving and so on
for following years.
Under the assumption made, the incremental cash flows of
leasing have a net present value of $92 151 after discounting at
7.63 per cent. As a consequence, in this case, leasing appears as
the best alternative.
Financial leases are popular (about 25 per cent of new capital
assets in Australia are leased) because there is a widely held
perception (Peirson et al, 2002) that:
• the cost of capital may be lower than that of other sources of
funds;
• suppliers’ finance involves lower transaction costs;
• as the lease is secured by the asset, the firm’s credit
availability is not affected;
• capital may be conserved;
• taxation may potentially be lower; and
• there are comparative advantages in asset disposal.
However, a valid theoretical argument may be constructed
(Peirson et al, 2002) that in an efficient finance market the point
of view of a lessor may in fact be a mirror image of that of a
lessee, and that many of these perceived advantages may prove in
the long-run to illusory.
INHERENT WEAKNESSES AND COMMON TRAPS
IN DCF ANALYSIS
Aside from the common error of mixing nominal and real dollar
term items in the same model, particularly when dealing with
depreciation and fixed-interest loans, there are other fundamental
Australian Mineral Economics
CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION
TABLE 10.7
600 000
3
30.00%
4.50%
3.00%
7.63%
2 3 4 5
-100 000 -100 000 -100 000 -100 000 -100 000
30 000 30 000 30 000 30 000 30 000
-60 000 -60 000 -60 000
-130 000 -130 000 -130 000 -70 000 -70 000
inherent weaknesses in DCF analysis. This is because a
DCF/NPV approach values and compares projects with
inherently different risk characteristics using the same risk-
and time-adjusted discount rate.
This leads to a view that larger, faster production rates will, in
the majority of cases, generate economies of scale and therefore
are the best alternative. If ‘the larger, the sooner, the better’ belief
is pushed to the limit, in the presence of large ore reserves and
disregarding possible market saturation effects on the price of the
commodity mined, the value of a mine will be optimised by
expanding capacity indefinitely. This, however, does not happen
in practice.
There is evidence that as the initial capital investment becomes
substantial, management becomes uncomfortable and intuitively
starts doubting the realism of its basic optimisation beliefs. Their
behaviour is easy to justify. This is because the variability of
project cash flows increases with the capital-intensity of
alternative project designs and is very sensitive to the levels
demand in terms of sales tonnages for the metal produced, as the
following simplified example of Table 10.8 illustrates.
Table 10.8 displays two alternative ways of developing a
project producing 30 000 tonnes per annum of a metal currently
priced $3000 per tonne. The first (A) is a capital-intensive design
resulting in $30 million annual fixed costs but in a low variable
unit cost of $1000 per tonne of metal produced. The second (B)
is a labour-intensive design with a relatively low annual fixed
cost at $10 million but high variable unit cost of $1667 per tonne.
At the current level of demand in terms of sales tonnages both
projects generate the same gross annual cash flow of $30 million.
However the cash flows of the capital-intensive project are more
sensitive to changes in volumetric demand than those of the
labour-intensive project. If sales tonnages fall or rises by 25 per
cent, the cash flow of project A falls to $15 million, or rises to
$45 million respectively. The volatility of its cash flows at 40.82
per cent is much higher than that of project B at 27.22 per cent.
Table 10.9 depicts the case where the same gross annual cash
flow of $30 million is achieved by two different projects, the unit
production cost of which are fully variable but different. In the
example the unit cost of production of project A, at $2000 per
tonne is lower than that of project B at $2500 per tonne. For
109
CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

TABLE 10.8
Comparing the risk of projects with different capital intensity.
Company A B A B
Capital intensive Labour intensive Capital intensive Labour intensive
Price ($/t) 3000 Tonnage demand volatility 25.00% pa
Production (t * ‘000) 30 30
Revenue ($‘000) 90 000 90 000 Sensitivity of gross CFs to changes in tonnage demand
Variable cost of production ($/t) 1000 1666.666667 30 000 30 000
Annual fixed cost ($‘000) 30 000 10 000 Low tonnage 22.5 15 000 20 000
Total annual cost of production ($‘000) 60 000 60 000 Base case 30 30 000 30 000
Gross annual cash flow ($‘000) 30 000 30 000 High tonnage 37.5 45 000 40 000
Standard deviation of CFs ($‘000) 12 247 8165
Standard deviation of CFs (%) 40.82% 27.22%

TABLE 10.9
Comparing the risk of projects with different unit operating costs.

Company A B A B
Low High Low High
Price ($/t) 3000 Price volatility % pa 25.00%
Cost of production ($/t) 2000 2500
Annual production (t * ‘000) 30 60 Sensitivity of gross CFs to price changes
Annual revenue ($‘000) 90 000 180 000 Low price 2250 7500 -15 000
Annual operating cost ($‘000) 60 000 150 000 Base case 3000 30 000 30 000
Annual gross cash flow ($‘000) 30 000 30 000 High price 3750 52 500 75 000
Standard deviation of CF ($‘000) 18 371 36 742
Volatility of CF (%) 61.24% 122.47%
Price of risk = percentage discount per 1.00% of CF volatility = 0.10% 6.12% 12.25%

project B to generate the same gross cash flow as A, it must
produce twice the sales volume of A, ie 60 000 tonnes per annum
instead of 30 000 tonnes.
A single discount rate attributes the same value to the annual
cash flow of both these projects. However, the high-cost project
B is more sensitive to variations in commodity prices than A. A
commodity price volatility of 25 per cent leverages the cash flow
variability of project B to 122.47 per cent, much more than that
of project A at 61.24 per cent.
It would not be objective to compare the values of projects A
and B in the two scenarios portrayed using a single discount rate
unless in the first case we had a take or pay contract and in the
second 100 per cent of production were hedged, thus neutralising
risk. To be more objective and still use conventional DCF
analysis we would have to apply progressively higher and higher,
‘risk-loaded’ discount rates to compensate for the increasing risk
created by high operating leverages.
One could ‘price’ the variability or risk of the cash flows of a
project by determining a specific discount rate for each
percentage level of cash flow volatility. Table 10.9 for instance
shows what risk discount rates appropriate to project A (6.12 per
cent) and B (12.25 per cent) would have had to be if a discount
rate equal to 0.1 per cent of the cash flow variability were to be
applied in addition to the risk-free rate of interest. Salahor (1998)
has demonstrated how this concept of ‘price of risk’ can be
derived and how it is in fact consistent with the risk-adjusted rate
of discount derived using the popular capital asset pricing model
(CAPM) logic. The derivation of ‘prices of risk’ is well beyond
the scope of this discussion.
The consequence of using the same discount rate is that riskier
projects may be overvalued compared with less risky ones.
Additional bias may also arise in DCF analysis by using a
single discount rate for both the riskier revenue and less risky
cost function of an individual financial model.
The variability of the price of some commodities can be as
high as plus or minus 100 per cent in a single year. This plays
havoc with the realism of revenue estimates. It is for this reason
that commentators describe mining projects as ‘price-risked’.
By contrast, much of the capital investment is in the present
and relatively easier to estimate correctly. One would also have
to be a very poor project planner and manager if one were to
incur recurrent operation and maintenance cost over-runs of say
over ten per cent. In addition management can generally devise
and implement strategies to keep costs on average on budget.
Depending on the relative timing of revenue inflows and cost
outflows choices may be biased against investing capital now to
save recurrent costs later and/or favouring future and more risky
patterns of revenue inflows.
This source of bias can be eliminated, as will be seen in
Chapter 12, by discounting the less risky operating costs of a
project at a lower rate than that of its riskier revenue using a
technique called modern asset pricing or MAP for short.
IDENTIFYING AND QUANTIFYING FINANCIAL
RISK: EXPECTED VALUE, SENSITIVITY AND
SCENARIO ANALYSES
A financial model constructed under an assumption of certainty
and based on single-point measurements and expected or mean
estimates of various input variables generates single point
expected results. As already noted, this type of model is often
referred to as the base case.

110 Australian Mineral Economics

 CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

Most inputs are, however, uncertain and the actual value, Sensitivity Analysis - Tornado

which will eventuate in nature according to their probability

Exchange Rate (US$:A$) 0.8 0.55
distribution of occurrence, may be significantly different from
Price (US$/oz) 320 440
that used in the base case model.
Headgrade (g/t Au) 3.6 4.5
From the base case one can determine the sensitivity of the
CAPEX (A$ million) -47 -35
project results to:
Diluted Mining Reserves (Mt) 1.8 2.2
• changes in the value of individual inputs (sensitivity Recovery % 0.9 0.97
analysis); or Mining Cost ($/t ore & waste) 2.4 1.8

• likely or extreme combinations of input values (scenario Milling Cost ($/t ore) 13 11.5

analysis); Waste:Ore Ratio 4.4 3.8

irrespective of their relevant probability distributions of -5.00 0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00

occurrence. NPV

Sensitivity and scenario analyses have been greatly facilitated

by the capacity to construct interactive models on computer
spreadsheets and by specialised risk analysis software. The
degree to which models can accommodate changes in input
variables is, however, limited to ‘relevant ranges’ beyond which
results become nonsensical. For instance one cannot test the
sensitivity of a project to a wide range of ore throughputs without
eventually having to change the size and capital cost of mining
and milling equipment and related unit operating costs. In other
words many project outcomes are not a continuous function
of input values, but rather step functions. For instance at a
reasonably high price for a commodity it may be optimal to plan
a large-scale open pit to achieve economies of scale, but if the
price of the commodity were to fall the need may arise to
high-grade production in a manner that would initially entail a
vastly different pit design. A sophisticated pit optimisation model
may handle a modest degree of price variability. However, more
significant price falls would make an open cut unfeasible and an
underground selective operation may be the only way to realise
some value out of the resources. Very few models are in reality
so sophisticated as to withstand extreme levels of variation in key
inputs.
Within acceptable ranges, however, sensitivity analysis
provides significant insights into the project risk, by determining
which input variable the project is most sensitive to. The ‘spider
diagram’ of Figure 10.3 shows how the mine project of Table
10.1 is typically highly sensitive to variation in factors affecting
its revenue (eg grades, prices, exchange rates, etc).
If one can estimate realistic ranges of possible input values, a
‘tornado diagram’, such as that of Figure 10.4, can be helpful to
assess and rank their impact and better focus the value of further
information. For instance one could firm up grades and tonnages
with some more drilling and a more refined resources model.
Alternatively a value study could be undertaken to trim the
capital investment estimates.
No amount of further research unfortunately will resolve the
uncertainty surrounding some of the inputs that are subject to
chance and to which the project is most sensitive. These include
Sensitivity Analysis - Spider
180%
160%
% Change in NPV
FIG 10.4 - A tornado diagram.
inputs such as exchange rates and prices. If the potential
consequences of their downside multiplied by their respective
probabilities of occurrence are too severe, the only course of
action is to manage the related risk by hedging or by rejecting
the investment.
PROBABILISTIC MODELS AND FINANCIAL
SIMULATIONS
In both the spider and tornado diagrams increments and ranges of
possible input values were used without any reference to their
respective probability of occurrence.
Analysts, however, are never completely ignorant and can do
better than attributing the same probability of occurrence (the
Laplace criterion) to any of the possible values for an input. For
the majority of inputs they have some knowledge of how their
values are likely to distribute, ie of the probability with which
various input values may occur. At worst they know their most
likely (modal), minimum and maximum possible values.
Depending on the nature of an input, its probability
distribution may be:
• discrete or continuous;
• symmetrical (eg rectangular, triangular, normal); or
• asymmetrical/skewed (eg triangular, log-normal, binomial,
exponential).
Many natural phenomena (eg grades, size of mineral and
petroleum accumulations, commodity prices) are characterised
by positively skewed lognormal distributions, in which the
logarithm of possible values distribute normally. Handling
lognormal distributions correctly requires considerable practice
and care. As an alternative, analysts often use an asymmetrical
triangular distribution as a surrogate.
It is a relatively straightforward exercise to substitute the
distributions of occurrence for selected inputs into the base case
model to replace original single-point estimates. This enables the
CAPEX model for financial Monte Carlo simulation using sophisticated
(A$ million) risk analysis software.
Diluted Mining
Reserves (Mt) The risk analysis software samples the various inputs
randomly, according to their respective probability distribution of
Headgrade

140% (g/t Au) occurrence over a very large number (thousands) of iterations of
120% Recovery % the model, in effect generating thousand of random scenarios.
100% This process not only generates the expected or mean values for
Price (US$/oz)
80% the various model outputs, but also the surrounding distribution
60% Exchange Rate of all possible outcomes and a range of relevant statistics.
40% (US$:A$)
Consider, for example, the result of a simulation carried out on
20% Mining Cost
($/t ore & waste) the mine model of Table 10.1, where probability distributions for:
90% 95% 100% 105% 110%
% Change in Input Value
Milling Cost • gold prices (lognormal),
($/t ore)
• exchange rates (uniform),
FIG 10.3 - A spider web diagram. • grades (triangular),

Australian Mineral Economics 111

CHAPTER 10: MINERAL PROJECT EVALUATION — AN INTRODUCTION

• recoveries (triangular), of distorting results, risk analysis software provides facilities to

• capital investment (uniform), and
• mining and milling costs (triangular),
have been used as inputs.
After 10 000 iterations the simulation generated an expected
NPV for the project of $12.89 million (very close to the base case
NPV of $12.69 million), within a positively skewed distribution
with a standard deviation of $8.68 million. The histogram of
Figure 10.5 shows that minimum and maximum NPVs of -$17.50
million and $64.43 million are possible, albeit with infinitesimal
probabilities of occurrence. The cumulative probability
distribution of Figure 10.6 shows that there is 5.78 per cent
probability of realising a negative NPV and 47.3 per cent
probability that the NPV will exceed the expected $12.89 million.
truncate them, preventing sampling below or above realistic
minimum and maximum values. In addition there may be some
correlation between the values for a single type of input over
successive years. These correlations and autocorrelations can be
incorporated in the model using modern risk analysis software,
which takes them into consideration during simulation and
adjusts the results accordingly.
Ideally the expected value derived from a Monte Carlo
simulation should, as in the example, be of the same order of
magnitude as that of the base case. A significant difference
indicates either a degree of inconsistency between the two set of
estimates, which should be reconciled, or a flaw in how the
probability distributions of the relevant variables have been
handled.

REFERENCES
RiskSim Histogram, 02-Jun-04, 11:08 am
4500 Bourassa, M J, 2001. International legal requirements and standards for
4000 mineral valuation, in Proceedings Valmin 2001 – Mineral Asset
3500 Valuation Issues for the Next Millennium, pp 62-83 (The Australasian
3000 Institute of Mining and Metallurgy: Melbourne).
Frequency

But also a lot

2500
There is a of “blue sky” JORC, 2004. Australasian Code for Reporting of Mineral Resources and
2000 chance of Ore Reserves (The JORC Code), The Joint Ore Reserves Committee
negative NPV
1500 of The Australasian Institute of Mining and Metallurgy, Australian
1000 Institute of Geoscientists and Minerals Council of Australia. [Online].
500 Available from: <http://www.ausimm.com/codes/jorc0105.pdf>. Date
0 accessed: 8 May 2006.
-20.00 -10.00 0.00 10.00 20.00 30.00 40.00 50.00 60.00 70.00
Lawrence, M J, 2001. An outline of market-based approaches for mineral
NPV, Upper Limit of Interval asset valuation best practice, in Proceedings Valmin 2001 – Mineral
Asset Valuation Issues for the Next Millennium, pp 115-137 (The
Australasian Institute of Mining and Metallurgy: Melbourne).
FIG 10.5 - Histogram of possible NPV values for the project.
Peirson, G, Brown, R, Easton, S and Howard, P, 2002. Business Finance,
eighth edition (McGraw-Hill Irwin: Sydney).
Roscoe, W E, 2001. Outline of the cost approach to valuation of mineral
exploration properties, in Proceedings Valmin 2001 – Mineral Asset
Valuation Issues for the Next Millennium, pp 138-146 (The
Australasian Institute of Mining and Metallurgy: Melbourne).
But also 47.3%
chance of
Salahor, G, 1998. Implications of output price risk and operating leverage
exceeding the for the evaluation of petroleum development projects, The Energy
There is 5.78%
expected NPV of Journal, 19(1):13-46.
chance of
$12.89M
NPV<0 Taylor, H K, 1978. Mine valuations and feasibility studies, in Mineral
Industry Costs (eds: J R Hoskins and W R Green) (Northwest
Mining Association: Spokane).
The Australasian Institute of Mining and Metallurgy, 1994a. Australasian
code for reporting of identified mineral resources and ore reserves
FIG 10.6 - Cumulative frequency distribution of possible NPV (JORC code) 1993, in Proceedings Valmin 1994, Mineral Valuation
values for the project. Methodologies, p B115 (The Australasian Institute of Mining and
Metallurgy: Melbourne).
The Australasian Institute of Mining and Metallurgy, 1994b. Code and
To ensure more accurate results, it is important to identify guidelines for assessment and valuation of mineral assets and
model inputs that are highly correlated, for example commodity mineral securities for independent expert reports (VALMIN code)
prices in US dollars and the exchange rate between the 1995, in Proceedings Valmin 1994, Mineral Valuation
Australian and US dollar, given the ‘commodity currency’ nature Methodologies, p B129 (The Australasian Institute of Mining and
of the former. There is also high correlation between grades and Metallurgy: Melbourne).
recoveries, grades and metal content of concentrates and related Torries, T F, 1998. Evaluating Mineral Projects: Applications and
net smelter returns. Clearly if in any iteration the computer were Misconceptions (Society for Mining, Metallurgy and Exploration:
to sample simultaneously anomalously high or low values at the Littleton).
extremes of the distribution for grades, prices, exchange rates VALMIN, 2005. Code for the Technical Assessment and Valuation of
and recoveries, it would generate erroneous extreme high or low Mineral and Petroleum Assets and Securities for Independent Expert
Reports (The VALMIN Code), The VALMIN Committee, a joint
values. While these should not impact the expected value of committee of The Australasian Institute of Mining and Metallurgy,
outputs they will widen the spread of their distribution affecting the Australian Institute of Geoscientists and the Mineral Industry
the realism of the simulation. To prevent extreme tails of Consultants Association (The Australasian Institute of Mining and
distributions generating combinations of unrealistically high or Metallurgy). [Online]. Available from: <http://www.ausimm.com/
low values (albeit at very low probability of occurrence) capable codes/valmin_2005.pdf>. Date accessed: 8 May 2006.

112 Australian Mineral Economics


Preliminary, Prefeasibility and Feasibility Studies
Richard West
Introduction
The Phases of a Project
Testing the Data – Technical Due Diligence
Types of Evaluation
Costs
Market Surveys and Commodity Prices
Financial Evaluation
Some Comments on Cut-Off Grades and Other Cut-Off Points
Risks and Sensitivities Associated with Feasibility Studies
Managing the Feasibility Study Process
Feasibility Study Reports
Appendix – Checklist of the Main Sections of Feasibility Study Reports
INTRODUCTION
The objective of this chapter is to present both basic and advanced
material on feasibility studies such that an inexperienced mining
industry professional can use it to upgrade their skills in the area
of feasibility studies preparation and management.
Key points covered include:
• items to be covered in the feasibility study process;
• selection of cut-off grades, and initial estimation of grades
and production schedules;
• estimation and verification of capital and operating costs
(fixed and variable costs);
• the use of scaling factors;
• selection of commodity prices and other economic factors;
• the cash flow model and financial assessment;
• financial verification of ore reserves;
• construction and production schedules including project start
up and commissioning;
• sensitivity analysis and risk assessment;
• orders of accuracy;
• feasibility study reports layout and content;
• legal requirements, professional competency, ethics,
standards of practice; and
• items to be included in a feasibility study report.
Australian Mineral Economics
CHAPTER 11
The feasibility study is used both to establish technical and
economic feasibility to develop a project, and to establish
technical and economic feasibility to make changes to an
existing project.
It is dependent on the project’s mineral resource conditions,
mining, metallurgical, other technical and marketing conditions
and the project’s economics, corporate philosophies, strategies
and structuring as well as the identification and satisfactory
mitigation of any serious project risks.
A key factor for a meaningful feasibility study is the integrity
of the underlying database. To demonstrate this, it is important to
undertake some form of ‘due diligence’ testing or auditing of
data, preferably on an independent basis.
Laird (1997) notes that:
Starting from a mineral resource database; the
feasibility study will define the ore reserves, the
mining methods, the mineral processing concepts
and the scale of the project.
The mining industry professional’s role in any analysis of an
existing or potential mining project is to provide technical advice
and information on parameters relating to design, extraction
methods, production costs recoveries, mining rates and the many
other variables, which will be used to technically and financially
appraise the project. To be a competent person, he or she must
understand the interrelationships and trade-offs between the
various project variables, the potential risks and problems
associated with those variables and must understand and
demonstrate how the project can address and manage risk.
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CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
Feasibility studies are an iterative process of deposit evaluations
extending from the initial ‘prefeasibility study’ through to the
‘definitive estimate’ undertaken with the objectives of:
• establishing the proved and probable reserves and the overall
measured, indicated and inferred resources;
• proving the technical viability of the mine and extraction
methods;
• defining the features and capacity of the facilities;
• estimating the development, capital and operating costs of
the mine over the economic life of the reserves;
• establishing the market opportunities for the commodity
produced by the project;
• completing financial assessments of the selected project
configurations;
• assessing the economic sensitivity of the proposed
development to various factors; and
• setting a framework for the implementation of the capital
investment in the development.
A feasibility study’s authors will utilise a mine financial
model, based on these plans, to calculate the effects of changes
in recovered grades, production rates with resulting mine life
changes and other important factors. In using this model they
typically seek to maximise the project’s net present value
together with an acceptable rate of return of investment funds.
In this process they conduct sensitivity analyses to test for
viability with increased strip ratios (in the case of open cut
mines), increased dilution, reduced recoveries, varying inflation
and escalation rates, commodity price movements, capital and
operating cost variations, grades resulting from changed cut-off
grades, effects of changes in production rates and mine life and
possibly project gearing. In addition it is important to test for the
sensitivity to grade changes. It is critical to understand and
discuss the potential impacts of these and associated risks in the
final report.
Once these studies indicate that the project is viable, it is
possible to report publicly the project’s ore reserves for that part
of the resource planned to be mined, together with any diluting
material (which the production scheduling has indicated will be
mined and delivered to the metallurgical treatment plant or
stockpiled for direct selling).
Preparing definitive cost estimates is usually the final stage of
project development or the first stage of construction, depending
upon whether the decision to proceed with project construction is
made before or after the preparation of these estimates. It is used
to provide the basis for project capital cost control and as an aid
in the establishment of and checking of construction contract
prices. As such, it is usually based on non-detailed site, layout
and engineering drawings and specifications. At this stage of the
project some quotations may have been called and the
construction schedule estimated such that the estimate can be
used as a bankable document for funds raising each of the papers
for further references to sections of this complex subject.
THE PHASES OF A PROJECT
The progression of an exploration discovery to
an operating mine took place in a phased and
iterative series of studies with identified decision
points (Yeates and Adams, 1998).
The major phases of a project are:
• exploration,
• evaluation and development,
114
• construction and commissioning,
• production, and
• project decline and closure.
The professionals involved in the project obtain the bulk of the
information about the deposit and its ore characteristics and
decide on its method of exploitation during the first three of
these phases.
The exploration phase includes a series of steps from
conceiving potential orebody models, through exploration to
delineate favourable targets (where such orebodies may be) and
testing of those targets. It concludes with the reporting of the
quantity and grade of mineralised material in the targets.
Should this assessment indicate that exploitation will not be
permitted, or that there is little possibility of discovering
mineralisation in a potentially profitable tonnes and grade
combination, there is no point in undertaking any further work.
Even though there may be significant mineral resources, there
are no ore reserves.
Professionals involved in the evaluation and development
conduct project scoping, select production rates, estimate plant
and equipment size, assess costs and structure the project to
cover investment, return borrowed funds and provide funds for
resource replacement.
TESTING THE DATA – TECHNICAL DUE
DILIGENCE
The resource base is of great importance because
it is the one element that cannot be changed. If
the process route is proved not to be suitable it
can be optimised or changed, if clear title is
challenged it can be legally defended, if the
quality of management is not suitable then new
people can be introduced to the project, but if the
resource base is flawed and the mineralisation is
not in the ground in a quantity that warrants
extraction then there may be nothing which can
be done (Amos, 1998).
Determining a project’s mineral resource is the result of a
complex accumulation of data derived from a variety of technical
and interpretational methods and processes. Audit testing is
essential to provide assurance of the quality of data used, and
that it is representative. It is also necessary to assess geological
interpretations of structure, grade and mineral zoning, and
mineral continuity. Furthermore, as the mineral resource moves
towards ore reserve status, it is vital to weigh up the validity of
additional technical assumptions, eg the metallurgical
characteristics of the resource.
Failure to thoroughly test key data at this stage may prove to
be a fatal flaw to the project. In particular, it is essential to take
great care when data come from third party sources with
unknown standards of technical diligence. This testing must
encompass all aspects of the data gathering and storage, database
validation checking drill hole surveys and appropriateness of
sampling and assaying techniques and records.
The technical due diligence program will probably require new
data to confirm previous results and to support interpretations.
Budgeting should allow for this.
Where they are to make major investment decisions, directors
and external financiers may require an independent third party to
test and audit these data.
Gilfillan (1998) describes the requirements for due diligence
review of geological data. Testing of all technical data is
important. However, the audit of data underlying the mineral
resource, and later the ore reserve, is critical since these form the
basis of the project.
Australian Mineral Economics
 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
Shillabeer (1998) has suggested that such audits should be
done twice, at different stages of the projects development. The
exploration period may cover many years, utilise a variety of
methodologies and a large number of people with different skills
and standards, therefore requiring review and recompilation.
TYPES OF EVALUATION
The most critical step of any project is the
feasibility study. Unfortunately the concept of the
term feasibility study has expanded to include a
whole range of activities varying from scoping
studies to the final feasibility study (Laird, 1997).
Evaluation studies generally evolve (as more exploration,
technical and financial data become available and the project’s
risks and sensitivities become better understood) through the
phases of:
• scoping or conceptual study;
• prefeasibility study;
• feasibility study (the bankable feasibility study is an
extension to the feasibility study that considers the project
from the bank’s perspective); and
• definitive estimate.
After each stage of development, conducting further
delineation and test work will generally be required before the
next stage of feasibility assessment can commence. In best
practice situations there is close cooperation and liaison between
the exploration crews and the personnel preparing and refining
the feasibility study.
Accuracy levels typically resulting from predevelopment
studies are:
• scoping or conceptual, ± 30-40 per cent;
• prefeasibility, ± 20-25 per cent;
• feasibility, ± 10-15 per cent; and
• definitive, ± 5-10 per cent.
The costs of feasibility studies can vary significantly. Some of
the key factors that influence this cost include the owner’s
management approach, methodology, type of resource, project
location and size and amount of consultant use. On some
occasions the cost of evaluation can be as high as ten per cent of
the total overall cost.
The feasibility study is an iterative process
Evaluation of mineral discoveries usually become an iterative
process that commences in the early stages of exploration to aid
the scoping of the potential project and continues throughout the
exploration phase as more data become available.
Project planning is also iterative in its nature. It involves
working and reworking this data, commencing with sensible
financial assumptions, mining and treatment factors and ore
cut-off grades. The mining engineer will consider the general
geometry of the orebody, including size and shape of all
geological features together with the nature of the breaking of
the ore, that may have an influence on the selection of the mining
methods, ore recoveries, dilution grade distribution and other
influencing factors. He or she refines conclusions as additional
data become available.
The following quotations by Northcote (1998) and Laird
(1997) add emphasis to these points:
The iterative approach to project development
underscores the significance of feasibility efforts
as a value improvement process. The capacity of
this process to add value is realised via
Australian Mineral Economics
optimisation of scope criteria from ‘reasonable
assumption’ through to ‘optimised design or
plan’ (Northcote, 1998).
During the late stages of exploration, and long
before a feasibility study is formally initiated, the
exploration geologists will have started to
develop a geologic model of the mineralised
structure. This will be expanded into a
preliminary resource estimate, which will guide
their continuing exploration activities and
provide an early indication of the potential of the
discovery. Ideally, this is an iterative process as
the results of drilling campaigns are manipulated
by the geologists and the geostatisticians,
additional information requirements are
quantified and new drilling programs are
implemented (Laird, 1997).
Evaluation of all mineralisation discoveries should be an
ongoing iterative process throughout the exploration phase. As
part of this there is a need to carry out a single or series of
preliminary feasibility studies to test:
• if mining will be permitted;
• if mining will be permitted, when and what restrictions are
likely to apply to any specific target;
• exploitation will be profitable; and
• exploitation will be technically possible.
This is an essential part of the normal exploration review
process. Where these studies indicate that a profitable venture
could be developed, it often becomes desirable to direct
exploration toward testing for extensions of the mineral resources
within profitable ore haulage distance around proposed treatment
plant sites. Where studies indicate located deposits to be
marginal or unviable, it is necessary to reassess the area.
Prior to making a positive commitment in key risk areas, a
project owner must also conduct a series of technical, social,
environmental and economic assessments. It is common practice
to commission consultants with specialist expertise in these areas
to produce the reports in these areas.
When such evaluation indicates that the project is potentially
profitable, the project owners will then assemble a technical team
to prepare a detailed feasibility study. This study contains more
in depth production planning and assessment of the quality and
quantity of ore including diluting material, which will be mined,
treated and sold. It also assesses the overall profitability of the
project.
Scoping or conceptual studies
Scoping or conceptual studies, to identify the general features
and order of magnitude parameters of the project, typically take
place soon after geologists have identified a potential mineral
resource. These studies identify technical issues requiring further
investigation or test work, as well as the costs and time required
to undertake further predevelopment.
With respect to scoping studies, White (1997) argues that:
This term is typically applied when only a very
preliminary examination is needed or in the
absence of specifics regarding the particular
project.
Where scoping studies indicate a venture may be profitable,
the direction of exploration may be changed to focus on those
areas developed early in the project’s life.
Where they indicate deposits to be marginal or not to be
viable, it is necessary to reassess the area. This will include
estimating and defining economic cut-off grades for resource
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CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
assessment and testing methods of developing the project with
differing operating parameters.
By following this process it is possible to refine many
assumptions, test sensitivities and assess areas of risk. The costs
and financial evaluations in these studies are only indicative or
‘ball park’ and are rarely sufficiently accurate to produce a
meaningful assessment of the viability of the project.
There should be close liaison between the exploration team
and the evaluating team in order to develop the project’s
operating criteria and objectives. The scope of the project will
evolve, as more data become available.
A well-constructed scoping study should:
• develop the project criteria and objectives and outline its
scope;
• establish the probable type of mining operation and assess if
mining will be technically possible;
• establish the probable type of treatment route;
• establish a metallurgical testing program to assess if
treatment will be technically possible;
• establish the probable marketing strategy;
• make a preliminary assessment of environmental factors that
could make it necessary to modify or drop the project;
• make a preliminary assessment of the project risks; and
• assess the potential for the discovery of resources capable of
supporting the proposed project.
Based on conceptual capital and operation costs, the study
should assess:
• the probable economic structure and operating criteria,
• probable cut-off grades and other cut-off points, and
• minimum deposit grades to return an acceptable return.
Scoping or conceptual studies usually are not sufficiently
accurate to carry out a meaningful assessment of the economic
viability of any project. Rather, their role is to determine
whether, and how much, further predevelopment efforts are
warranted.
The prefeasibility study
The prefeasibility study seeks to establish technical and
economic feasibility to develop a new project or to make changes
to an existing project. It is a non-detailed evaluation based on
preliminary planning and engineering and associated ore reserve
assessment. Such a study takes place prior to setting up a
high-powered and probably high cost engineering project team.
It is dependent on a first-pass estimate of the likely conversion of
the mineral resources delineated during exploration into possible
mining reserves, mining, metallurgical, other technical and
marketing conditions.
The project’s financial analysis should take account of
corporate philosophies, strategies and structuring of the project.
It should also identify and suggest satisfactory mitigation of
major project risks.
Cusworth (1993) suggests the following:
Once sufficiently accurate information is
available on the mineral resource (see later for
guidelines) prefeasibility studies can be
undertaken with the objectives of:
• assessing the probable reserves and the
approaches to recovery,
• identification of the techniques and rates of
extraction,
• outlining the possible features of the facilities,
116
• developing capital and operating cost
estimates,
• testing the marketability of the commodity,
• assessing the economic viability, and
• determining what further efforts are required
to allow the predevelopment activities to
advance.
Prefeasibility studies are generally sufficiently accurate to
allow a comparative analysis of the financial viability for
alternative capacity and project configurations.
Ground conditions including jointing, faults, areas of shear,
stress directions, weathering and unweathered areas in addition
to orebody thickness may dictate the use of specific mining
methods. Both surface and underground conditions will often
dictate the siting of key items as the shafts, treatment plant,
power station and other supporting infrastructure.
The early mine planning and ore reserve estimation for metal
mines initially overlap with one another. This early phase
consists of planning the method of extraction usually, based on
an assumed breakeven cut-off grade, producing a production
schedule. Consideration of ore quality and contaminants
becomes very important in determining the limits of minable
orebodies in the case of non-metallic, coal and some metallic
commodities.
The sales return from the planned production schedule, less
various royalties and taxes will indicate the project’s cash flow
and its likely viability under the assumed production conditions.
As we have seen it is normal practice to convert these to present
money values.
As more information becomes available, the re-assessment
refines the production schedule and the ore reserve.
As with the identified mineral resources computer modelling,
project analysts may alternatively utilise manual modelling to
plan the production schedule and optimise the mining and
treatment operations, as well as model the financial
characteristics and estimate the ore reserves.
A project may evolve considerably as a result of an initial
prefeasibility study, reflecting corporate philosophies, structures
and development strategies.
The prefeasibility study may become a long iterative series of
evaluations being progressively updated and modified as
exploration data and the exploration geologists progressively
report mineral resources. Analysts usually investigate project
financing during this time.
Prefeasibility studies are more detailed than scoping studies.
They include:
• determining operating costs, considering operating and
maintenance labour, power and other services, consumables
and maintenance spares;
• determining capital costs, including working and
replacement capital;
• assessing the mining methods, treatment routes and
identifying cut-off factors, recoveries, dilution and losses in
both mining and treatment;
• assessing potential reserves out of delineated resources based
on non-detailed mine planning and production scheduling;
• outlining probable plant, infrastructure, services and other
facilities;
• producing a summary development structure and timetable;
• developing a philosophy of plant quality (including
maintenance philosophy);
• evaluating the specification and marketability of the
commodity;
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 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
• setting up the economic evaluation model; and
• determining financial viability.
Cusworth (1993) notes that:
Based on the alternative sizes and configurations
evaluated during the prefeasibility stage, one size
and configuration is generally selected and the
technical and economic feasibility established
within the accuracy limits of the available data.
Prefeasibility studies are generally sufficiently accurate to
allow a comparative analysis of financial viability for alternative
capacity and project configurations. They usually include a
review and evaluation of development alternatives, a report on
liaison with government departments and often also with bankers
or other potential financiers.
During each iterative cycle of the study, analysts should assess
what further exploration, mining tests and metallurgical tests and
other studies are required to allow the predevelopment activities
advance to the stage where a full feasibility study is possible.
An important point is reached when a prefeasibility study
indicates that a project is financially viable, and there are no
social, political, environmental or other reason why mining and
treatment will not be permitted, At that time a company in
Australia can publicly report as ore reserves under the JORC Code
(2004) that part of the resource, together with any diluting material
(which planning has indicated will be mined and delivered to the
metallurgical treatment plant or stockpiled for direct selling).
The feasibility study
Feasibility studies take place at two levels:
• for internal final assessment purposes, or
• for obtaining external funding.
The latter type is a bankable feasibility study.
While prefeasibility studies evaluate alternative sizes and
configurations, feasibility studies generally concentrate on one
size and configuration, seeking to establish technical and
economic feasibility within the accuracy limits of the available
data.
A team of multidisciplined persons, possessing complimentary
skills normally carry out such feasibility studies. There is input
from mineral economists, metallurgists, mining engineers,
construction engineers, geologists, environmentalists, and
marketers and others.
Feasibility studies have the objectives of:
• defining the mine’s plant, equipment and infrastructure
requirements and capacities;
• establishing the proved and probable reserves;
• assessing project alternatives and selecting the desired
development route;
• evaluating and defining the role of the owner during
development;
• establishing legal and governmental conditions and
requirements for approvals to proceed;
• proving the technical viability of the mine and extraction
methods;
• defining the management control and timing of the project
development and construction;
• defining the commissioning of the project, recruiting and
training of the management team and crew and hand over at
the conclusion of construction;
• estimating the development, capital and operating costs of
the mine over the economic life of the resource;
Australian Mineral Economics
• identifying the market for the commodity;
• estimation of capital costs based on non-detailed engineering
planning and estimates and some quotations;
• estimation of operating costs considering operating and
maintenance labour, power and other services, consumables,
maintenance spares and where possible quotations for
contract works;
• assessing project risk areas, economic sensitivity to those
areas and action that may be used if the risk becomes a
problem;
• completing economic assessments of the selected project
configurations;
• developing financial models showing cash flows showing
sales revenues, capital and operating costs, proposed project
gearing, revenues, loan servicing and payback and project
sensitivity to financial and operating sensitive areas; and
• setting a framework for the implementation of the capital
investment in the development.
Analysts use a mine financial model based on these plans to
calculate the effects of changes in recovered grades, production
rates (with resulting mine life changes) and other variable
parameters, until they produce a maximum present value,
together with an acceptable rate of return of investment funds. As
mines differ in so many ways (some having unique features)
tailoring of the model is usually required.
Ground conditions (including jointing, faults, areas of shear,
stress directions, weathering and unweathered areas) in addition
to orebody thickness may dictate the use of specific mining
methods. Both surface and underground conditions will often
dictate the siting of key items as the shafts, treatment plant,
power station and other supporting infrastructure.
Both the physical and chemical nature of ore, its contained
gangue and mine waste can potentially have serious effects on
the environment in the immediate area of a mine. In high rainfall
areas this can also extend a considerable distance down stream in
neighbouring streams and rivers. It is important to recognise this
early in the resource definition phase. It may affect the siting of
mine towns, site access roads, power lines supporting
infrastructure, dumps, tailings dams and other infrastructure.
During detailed feasibility studies sensitivity is essential to test
for viability with increased strip ratios, increased dilution,
reduced recoveries, varying inflation and escalation rates,
commodity prices, capital and operating costs, grades resulting
from changed cut-off grades, effects of changes in production
rates and mine life and possibly project gearing. In addition it is
important to test the sensitivity to grade changes.
Bankable feasibility studies
Mine development often requires the injection of more funds
than the mining company can, or wishes, to raise as equity.
Prior to providing funds to a mining project, a banker will
require disclosure of cash flows showing sales revenues, capital
and operating costs, proposed project gearing, revenues and
proposed loan servicing and payback, all of which should be in
the feasibility study.
A prospective banker also requires evidence that a company’s
management team has the ability effectively to manage and
coordinate the various phases of the project.
They also require reports from independent sources, covering
selected areas already covered in the feasibility study. They use
these independent reports both for initial due diligence purposes
and for project monitoring during the preproduction phase.
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CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
The most commonly requested independent reports cover:
• verification of resources and ore reserves;
• capital and operating cost estimates;
• technical feasibility of mining methods;
• geotechnical and groundwater considerations;
• processing technology and predicted metallurgical
performance;
• management capability of the operator for both the
construction and production phases;
• technical reviews of environmental impact statements;
• availability and security of essential services such as power
and water;
• risks associated with transporting and selling product;
• risks associated with natural disasters;
• political, social and industrial risks;
• product marketing;
• environmental impact and permitting; and
• access and land rights matters.
A banker will also usually develop a cash flow model based on
a production schedule derived from the project’s resources and
reserves, prepared by an independent mining consultant.
He or she will use this model to test sensitivity to operating
and capital cost overruns, production and recovery variations,
commodity price and exchange variations and the combination of
several variations. When these have been completed, he or she
will appraise the basic strengths of the project and offer the
borrower alternative loan packages.
A banker requires a project life, which exceeds the term of the
loan and he or she will build in contingencies for cost overruns,
production and recovery short falls and market fluctuations.
The extent to which a project depends on input from
independent sources depends on many factors. From a banking
perspective, the requirement for independent reports depends
very much on the risk profile of the project, the track record of
the project sponsor, the type of bank, its credit culture and its
in-house ability to assess mining project risk.
For a single bank financing, there may be no specific
requirement for independent reports. However, for syndicated
financings, it is usual for banks to request a significant level of
independent reports to be prepared, both for initial due diligence
purposes and for project monitoring during the preproduction
phase and the period of loan payback.
The depth of investigations is influenced by the perceived
competence of the mining company, the existence of assets besides
those of the specific project, type of commodity, nature of the
proposed project and any related environmental and political factors.
Early exposure of bankers to the project through presentations
by the exploration and project evaluation team, usually enhance
loan negotiations. Bankers are reassured when they carry out due
diligence activities, if there has been a significant amount of
independent work undertaken on the project, particularly in
respect of key risk areas.
It is important to consider carefully the preparation of
independent reports during the early stages of project
development to avoid duplication of effort and reduce evaluation
costs and time. Anticipating a banker’s likely requirements will
be of significant benefit to the project.
Definitive project cost estimates
It is possible to prepare a definitive project cost estimate after the
completion of a feasibility study. This requires accurate estimates
of design, supply, transport, construction and preproduction
118
costs. A project’s principals will view this either as the final
stage of project development or the first stage of construction,
depending upon whether they have decided to proceed with
project construction before or after the preparation of these
estimates.
A definitive project cost estimate provides the basis for project
capital cost control and aids in establishing and checking
construction contract prices. As such, it is usually based on
non-detailed site layout and engineering drawings and
specifications. At this stage of the project some quotations may
have been called and the construction schedule estimated such
that the estimate can be used as a management control budget
during construction.
The construction phase of the project effectively commences
following the decision to develop the project. It includes the
detailed mine, metallurgical planning and detailed engineering
design. From this follows procurement of equipment, the
engineering construction and mine development.
Mining and treatment commence with project commissioning.
This phase includes recruiting and training the operating crew
and sorting out operational and equipment ‘bugs’ such that the
operations settle down to become routine. This is the point at
which the project enters the production phase.
Planning and evaluating the following activities contribute to
generating the definitive project cost estimate:
Owner management activities
• Establish the project personnel and management information
systems;
• set the project implementation strategy including the
contracting plan, commissioning, operating structures and
the preproduction approach; and
• call tenders, select and appoint consultants or contractors
and/or engage the project execution team.
Project management
• Specify the scope of work, design criteria and quality
parameters for the project;
• complete sufficient engineering design to eliminate technical
risks, allow accurate quantity and derive labour hour
estimates;
• obtain and evaluate firm quotations for the supply of large or
key equipment items;
• obtain and evaluate firm quotations for the supply,
fabrication and transport of a large proportion of bulk
materials;
• obtain firm tenders for the erection and installation
construction works of the larger or critical contracts;
• accurately define the costs of remaining engineering and
construction management services; and
• set the schedule for all remaining works to develop a series
of firm completion dates for supply, construction,
commissioning and pre-production activities.
Applicable codes and professional competency
The JORC Code (2004) and the VALMIN Code (2005) currently
represent best practice standards in the Australian minerals
industry. Although feasibility studies are usually internal
company documents, extracts from them usually become
appended to various public documents and should be regarded as
being in the public domain. Thus it is highly desirable that they
accord with and follow both the JORC Code (2004) and the
VALMIN Code (2005). As there is always a possibility that
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 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
information not conforming with these codes could get in the
public arena, it is important that feasibility studies note and
explain formally the reasons for such departure from the norm.
A team of multidisciplined competent professionals having
complementary skills, including mineral economists,
metallurgists, mining engineers, geologists, environmentalists
and marketers, usually carries out evaluation studies.
The competent person signing off the report, must understand
the interrelationships and trade-off between the various project
variables, the potential risks and problems associated with those
variables and possess the planning ability to compensate for or to
reduce the effects of such problems as they occur. They must
understand and manage risk and should incorporate ‘best
practice’ in their work.
The basic principles that apply to a properly conducted
feasibility study are similar to those in the VALMIN Code (2005)
– due diligence, materiality, transparency, reasonableness and
professional competence.
COSTS
Factors such as the selected production rate, the selected mining
methods, waste to ore ratios, the mine’s geometry, treatment
route, infrastructure requirements and the propensity of some
engineers to place best quality ahead of just achieving fitness for
purpose (the Rolls Royce factor) will all influence a project’s
capital and operating costs.
A common way to design a project with low operating costs is
to install robust mining, treatment and infrastructure facilities.
This incurs a substantial capital cost but may be appropriate
where the project has a long life and the product is ‘low value
and high volume.
The opposite case of low capital with a high operating cost
may be more suitable for a short life small production high value
product mining operation.
The range of factors that will influence the capital and
operating cost profile of a new mine include the company’s
corporate policy, the nature of the deposit, its potential life,
production rate, the company’s need and ability to raise capital,
the company’s perceived risk profile and its ability to repay
borrowings.
Establishing the various relationships between costs and a
project’s production capacity involves identifying fixed,
semi-fixed and variable cost elements throughout the mining and
treatment routes. It also involves defining appropriate
dependencies to aid the development of factoring methods.
As production activities increase or decrease, so does the total
cost. Where a given component of the total cost changes in direct
proportion to the production rate, it is a variable cost. Where a
given component of the total cost remains unchanged for a given
time despite variations of production, it is known as a fixed cost.
There are some costs that remain fixed costs until there is a
major change in production. These are stepped costs. They are
usually fixed costs until there is a radical variation in production.
As part of specifying the most cost effective production rate
and design for a project, it is necessary to select a series of
production rates, estimate their capital and operating costs then
assess the combination, which maximises the project’s net
present value.
Capital costs
In the mining industry, the capital cost of a project generally
means the total investment required to bring the property into
production. It includes the estimated costs of all phases of
development, construction, the management of these phases and
project commissioning. On many occasions, capital expenditure
will continue after mining operations have been commenced and
optimised.
Australian Mineral Economics
Capital costs usually include:
• tenement acquisition;
• exploration (if not offset against other operations);
• feasibility studies and planning (from the end of exploration);
• environmental studies;
• mine development;
• mine plant and equipment;
• site preparation;
• treatment plant;
• tailings disposal;
• workshops, offices, warehouses;
• power supply;
• water supply;
• site support infrastructure;
• accommodation and amenities;
• design and engineering expenses;
• temporary construction facilities and plant;
• owner’s costs;
• a contingency for items not included (this is not a buffer for
holding money to give cover for bad estimation); and
• working capital (this includes the initial stock of spares, first
fill, recruiting and training during commissioning and
operating costs until regular returns on sales are established –
it is often equivalent to four months of operating costs).
Other items of capital that are often overlooked include:
• replacement capital during operations, and
• mine closure costs offset against salvage value at mine
closure.
Replacement capital includes the cost to replace major items
of plant and equipment (mine trucks, excavators, bulldozers and
so on) during the life of the project.
Post-production capital includes the cost to remove mine plant
and equipment, remove foundations, to make the area safe and to
clean and complete rehabilitation of the area at mine closure.
This is offset against any plant and equipment salvage payments
and recovery of working capital.
A schedule of capital expenditure should be compiled initially
on an annual basis then as the estimates become more detailed
quarterly or monthly for the construction and initial operating
years.
There usually are insufficient data available for more than
preliminary planning and engineering in the early stages of
feasibility assessment, and the project’s scope of work rarely is
fully defined. Thus, often it is only possible to prepare an ‘order
of magnitude estimate’ of the project’s capital costs.
In this early stage of cost estimation, it is common to use a
factoring procedure to equate capital costs from recently
constructed projects to the new project. The analyst may use the
experience of similar operations to estimate capital and operating
cost and then apply factoring to estimate the costs at other
production rates. However, as more scoping and engineering
design proceeds, the project may be broken down into elements
and the cost of each element may be factored for changes in
production.
There are many forms of factoring. One commonly used
formula for adjusting the variation of capital costs with
production is the seven tenths formula (exponential capacity
factoring) below.
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C2 = (P2/P1)7/10 C1 Accuracy levels typically resulting from predevelopment cost

estimates are:
where:
C2 = cost estimate of project 2 at production P2 Percentage
Scoping ± 30-35
C1 = cost estimate of project 1 at production P1
Prefeasibility ± 20-25
P2 = installed production rate of project 2
Feasibility ± 10-15
P1 = installed production rate of project 1 Definitive ± 5-10
The factor varies from 5/10 to 9/10 but for mining project
Source: Cusworth (1993).
capital costs is generally around 6.5/10 to 7.5/10.
In the early stages a global capital cost from a similar project Operating costs
may be modified using this factoring system, keeping in mind
that these rule of thumb are only order of magnitude and in some Estimating operating costs is generally more difficult than
cases can be quite inaccurate. estimating a project’s capital costs. This is due to the uniqueness
Typical individual factors are: of a deposit, mining and treatment method, location and each
company’s operating philosophies. Yet cost engineers often pay
• mine 0.65-0.85 less attention to estimating operating costs than to capital costs.
• treatment plant 0.55-0.75 Most mining companies collect their costs in the following
• town, site accommodation 0.65-0.75 major areas:
• workshops 0.65-0.8 Exploration
• power station 0.75-0.9 Mining
• surface works 0.75-0.85 Surface mining
• offices, warehouses, buildings 0.7-0.8 Waste and over burden removal

Attempts to use rules of thumb and factoring methods based Ore extraction
on linear and log-linear trends to provide a quick indication of Surface mining general (general pit dewatering, day works and
the probable capital cost of a project, including: haul road maintenance, etc)
• the turnover ratio method, Underground mining
• the module cost method, and Mine and stope development
Ore extraction
• installed capital cost per tonne of annual production,
Ore transportation ex mine
are not appropriate over large production rate differences and can
in some cases lead to significant errors. They should never Underground mining general (ventilation, dewatering, access
replace estimates based on more detailed planning and maintenance, research, overheads)
engineering carried out by professionals experienced in the Mine general (supervision, mine planning, grade control, immediate
specific areas and commodities. mine area exploration research, safety, training, overheads)
The resource type, size, the capital cost, the approach, Treatment
structures, resources and time allocated for each stage will Crushing
dictate the costs of predevelopment.
Grinding
Projects with high environmental, industrial or market
sensitivities require higher predevelopment costs in areas such as Concentration
feasibility studies and planning (from the end of exploration) Tails and waste disposal
metallurgical testing, mining studies, environmental studies and
Dump restoration
the owner’s expenses during this period.
The program of development can also significantly affect the Treatment general
‘standing’ costs of the owner’s personnel allocated to the Administration
predevelopment stage. Corporate
The contingency allowed in a feasibility study is the amount
assigned by experienced estimators to cover costs that will occur, Some companies have a separate engineering operating cost
but for which it is not possible to establish a specific scope from section. Others may include engineering as a separate area or
available drawings, specifications or schedules. A contingency is include it as part of the exploration, mining and treatment.
to allow for changes in scope, capacity or schedule. Members of
the feasibility study team estimate it from experience based on It is usual to divide the above cost areas further into:
the quality of definition available at the time of the estimate • salaries and on costs;
preparation. It is a true estimated cost over which no discretion
can be applied as to whether it will or will not be expended. • wages and on costs;
Contingency amounts applied to capital cost estimates at • contractors;
various stages of feasibility study are as follows: • consultants;
Contingency Percentage of capital cost • services (power, water, compressed air, communications);
Scoping and conceptual 20-25 • fuel and lubrication;
Prefeasibility 15-20 • consumables;
Feasibility 10-15 • spares and tools;
Definitive 5-10 • reclamation;
Source: Cusworth (1993). • royalties and taxes;

120 Australian Mineral Economics

 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
• administration, general office, accounting and legal costs;
• public relations;
• recruitment and training;
• safety;
• accommodation;
• transport; and
• marketing and selling.
Depending on how companies collect costs, they may
separately report areas such as maintenance, supervision,
accommodation, reclamation, off lease transport and marketing.
Another possibility is to consolidate them into administration.
These costs are usually further split up into direct or variable
costs that are related directly to production and fixed annual
costs or indirect costs that are independent of production and are
dependant on time.
In practice, changed output rates will usually have a minor
effect on the fixed costs.
The fixed annual cost component usually includes:
• salaries and on costs;
• some wages and on costs;
• part of services (power, water, compressed air, communications);
• training and safety; and
• corporate overheads.
Where there are major changes to the production rate, the
salaries and wages costs should be treated as stepped costs rather
than fixed costs.
The variable component usually includes:
• some wages and on costs;
• part of services (power, water, compressed air, communications);
• contractors;
• consultants;
• a major part of services (power, water, compressed air,
communications);
• fuel and lubrication;
• consumables; and
• spares and tools.
MARKET SURVEYS AND COMMODITY PRICES
The interaction of the forces of supply and demand determine
mineral prices. An important part of any feasibility study is the
market survey. This should indicate the probability of contractual
sales under forward conditions. It also should report smelter and
refining charges (depending on the type of commodity being
sold) and other selling costs, charges and commissions. These
data establish the net revenue received on sales from the project’s
production.
Sometimes the banks financing a project will not fully
understand the nature of a mine’s production, or the markets in
which the project will operate. In these cases they may require
independent market studies to address specific market issues.
A mineral market survey usually addresses the following
matters:
• product specification and risk contaminants;
• quality control and penalty criteria;
• current market suppliers and purchasers;
• geographic location of main market areas relative to the
project and their influence on the project;
Australian Mineral Economics
• size of the market;
• rate of demand growth or decline;
• rate of supply growth or decline;
• possible events, new technologies, replacement materials that
could influence market and possible net effect;
• the pattern of commodity prices over the past several years
and considering the above points, a projection of future
trends; and
• the prospects for selling forward to reduce the risks of
commodity price downturns during the early production
years of the project.
A key part in any mineral market survey is an estimate of
future price trends. There are several possible approaches to
identify these trends. While these are usually commodity
specific, they usually include:
• a review of the past price trend cycles, with an assessment of
future economic conditions over the anticipated project life;
• estimates of the costs of competitive producers, relative to
the project’s predicted costs, to assess the relative chance of
survival of the project during commodity price downturns;
and
• associated econometric models that quantify relationships
between supply, demand, commodity inventories, the various
producers’ technical factors and expected future price trends.
All these methods aid the estimation of future prices, their
fluctuations and trends during the life of the project.
Based on these and the project’s production schedules and
recoveries, it is possible to prepare revenue forecasts. These
should contain potential down-side and up-side levels,
assessment of risk areas and plans for contingent action.
Uncertainties in predicting commodity prices include
associated escalation, the effect of exchange rate movements and
capital and operating cost inflation. Some market studies
incorporate factors to handle these uncertainties while others
resort to using constant dollar conditions and use reduced interest
rates when estimating their present values of the project. It is
more realistic to assume an escalating dollar and analyse
sensitivities to different capital and operating costs and
commodity prices to test the effects on the project viability.
FINANCIAL EVALUATION
The cash flow
The cash flow of a mining project is the after tax funds available
to the company. It is usually based on annual cost figures.
However, at project construction and in the early stages of
operations, it may be necessary to prepare the cash flow over
shorter periods for cost control purposes. These are usually
reported annually.
A project’s after tax cash flow includes the following
components:
• net revenue from sales after selling expenses;
• plus other income (toll treatment, earnings from investments,
etc);
• less operating costs, exploration costs, state royalties, interest
and GST;
• less taxation;
• plus borrowed funds and equity injections;
• less capital expenditure;
• less principal loan repayments; and
• equals after tax cash flow.
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CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
A project’s depreciation does not reduce its cash flow.
However, it is a legitimate deduction in each period to determine
tax payable.
When gearing is included in the cash flow, assumptions are
necessary about the timing and the amounts to be paid back to
the lenders and the interest to be paid on the outstanding loans.
The project payback period (ie the point in time when the
cumulative net cash flows from production balance the project
development and construction outlays on an undiscounted or
discounted basis) is an important break-even point to the project
lenders and owners.
Lenders are primarily concerned about the realism of a project
cash flow capacity to service its debt and repay the related
principal over the period while their loans are outstanding. While
not overly concerned about the project whole-of-life
performance beyond repayment of their loans, would consider
projects with a long operating life beyond the project payback
period more favourably. Their risks of loans default are much
reduced if there is no project commissioning slippage, as there
would also be reduced risk with the accuracy of predictions
about future commodity prices, exchange rates and costs.
As discussed in Chapter 10, in order to obtain a meaningful
valuation of the project, it is necessary to take into account the
time value of money by bringing back to the present time, each
period (usually annual) of future cash flow produced during the
planned life of the project. The present or initial period is not
discounted. This is known as the present value (PV) method of
measuring the value of the project. The formula for calculating
the present value of cash flow in each period is:
Present value = cash flow/(1+discount rate)t
It may also be expressed as:
Present value = cash flow*(1+discount rate)-t
where:
t is the number of time intervals from the start of the project to
the particular cash flow being discounted to its present value
In the initial year from which the time periods are being
measured, t = 0 and the cash flow for that period is the present
value.
The sum of all the present values of each period net after-tax
cash flows is the net present value (NPV) of the project. Thus,
the NPV of a project is the total sum of money in today’s money
values of the present and future cash flows discounted at a
specified interest rate, ie:
NPV = ∑ t=0 to n (CFt / (1+discount rate)t)
At mine closure, project buildings, plant, equipment, residual
stocks in the warehouse and the working capital have a residual
value. However, expenditure is necessary to clean up and
rehabilitate the project site. These expenditures should be
included in the cash flow. They appear either in the last year of
operation or in the following year depending on plans to carry
out the project closure and clean up. They, as part of the cash
flow, must also be discounted to their present value.
The setting of the project’s discount rates must be matched to
the factors included in the cash flow model. Such factors include:
• the corporate cost of raising equity funds, with cognisance of
perceived project risk;
• the corporate cost of borrowing funds;
• the amount of debt as a proportion of total funds employed
and the effective corporate tax rate;
122
• whether real (constant) or nominal money values incorporating
the effect of expected inflation are being used; and
• company corporate policy.
The theory underlying the determination of the cost of equity
using the capital asset pricing model (CAPM) and the
methodology for computing the weighted average cost of capital
(WACC) have already been covered in some depth in Chapter 10
to which the reader is referred.
Generally, discount rates are higher when a project is at an
earlier stage and the inherent project risks are higher. So at a
scoping conceptual stage the real rate of discount may be as high
as 17 to 27 per cent. As more project data become available and
the feasibility study becomes more detailed, the risks reduce and
the discount rates fall accordingly. At the definitive stage real
discount rates could fall to as low as eight to 12 per cent or less.
The project owners normally compute and set the discount rates
as a matter of policy, with the agreement of the professional
signing off the feasibility study.
Project optimisation
Optimising a mine plan requires a sound workable plan, which
minimises cost and maintains the various project risks at a
manageable level, while achieving maximum profit in present
value terms. A major component of this is understanding the
characteristics of the mineral resource project development
capital options, mining parameters and conditions and
metallurgical conditions, considering that these conditions may
change during the production period. Computer modelling can
enhance this understanding.
During a detailed feasibility study, the optimisation process
includes assuming various production plans on a timed basis
such that the variables, which have an effect on the project’s
profitability, are varied in differing combinations to maximise
profit. This requires considering different mining plans and
extraction sequences to test for increased profitability with
increased strip ratios, increased dilution, grade variation, reduced
recoveries, commodity prices, capital and operating costs, grades
resulting from changed cut-off grades, effects of changes in
production rates and mine life and possibly project gearing. As
an illustration of this process, Christie (1997) presents a useful
case study in data interpretation, orebody definition, and
optimisation at the Red Dome deposit in Queensland.
SOME COMMENTS ON CUT-OFF GRADES AND
OTHER CUT-OFF POINTS
It is a misconception that only the cut-off grade will directly
determine which blocks of the identified mineral resource should
be mined. Ground conditions, including jointing, faulting
shearing, areas of weathering, orebody geometry and physical
depth will usually dictate the use of specific mining methods.
Mine access to areas, ground support requirements and other
mining constraints often dictate the mining of lower grade
material or the leaving of some higher grade material such as
unrecoverable pillars in underground mines. Where such pillars
are left and no plan exists to recover the pillars then the pillars,
while part of the mineral resource, are not part of the ore reserve.
In addition, as a result of deposit geometry, some ore may be
left and there may be a need to mine barren or sub-grade
material. These together with the spalling of weak barren wall
material will result in the ore being diluted and ore recovery
being reduced. It is essential to take account of this dilution and
the recovery of ore from within the mineral resource envelope in
assessing the ore reserves.
In most mines the marginal cut-off grade in the stope in an
underground mine and in the working bench in an open cut mine,
is assumed to be equal in value to the variable costs when the
treatment losses and other factors are taken into account.
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 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
It is normal practice to send material between the operating
cut-off grade and the marginal cut-off grade to a low-grade
stockpile. This is treated at times of reduced mine production to
maintain the mill at its optimum production rate. Processing
surplus material also takes place as mining operations slow
toward the end of the economic mine life. Treating marginal
grade material, early in the life of the mine instead of ore above
the design cut-off grade will reduce the project’s NPV.
It is necessary to mine some material, which has sufficient
grade to allow it to be treated covering the variable treatment
cost, but has insufficient grade to be classified as marginal
material. This permits the mining of profitable ore. This is
usually stockpiled as low-grade ore for treatment either when
there is an ore supply problem in the mine or at some future time
when the project’s economic conditions are more favourable.
Having made this point, a mine’s managers should avoid causing
negative cash flow and mining and treating material that does not
cover variable costs.
RISKS AND SENSITIVITIES ASSOCIATED WITH
FEASIBILITY STUDIES
Any evaluation of a project’s robustness must take into account
its various risk areas and the potential for adverse interaction of
those risks on the project.
Butler (1994) argues that:
The cash flow model will then be run under a
number of sensitivities with each of the critical
parameters (for example costs, commodity
prices) varied separately and systematically to
test the project’s robustness to variations in these
factors.
Feasibility studies provide the opportunities to evaluate risk
factors prior to developing a mineral project and, in this way assist
in maximising the success of the venture. Such studies are based
upon a series of assumptions about future mining, treatment,
market and economic conditions, all of which carry risk.
But some other comments are worthy of note. Rozman (1998)
notes that:
The resources business like so many others is all
about managing risk. If all we do is minimise
risk, many a viable business opportunity will be
lost.
Seymour (1998) argues:
The key objective of a mining company in to
maximise shareholder contribution within
acceptable risks. In order to achieve this, the
mine planning process must be adequate to
deliver the ‘promise’ and to protect the future of
the mine.
Effective risk analysis allows consideration of both anticipated
problems and unexpected occurrences. During the feasibility
stage there is usually a relatively minor cost to plan for the
ability and flexibility to take contingent action to handle
unexpected conditions and to rectify or control problems. If this
planning does not take place unexpected problems during
production may lead to major expenditure and production losses.
The most common factors or risks, that contribute to or reduce
the estimated value and success of any mining project, include:
• risks associated with the project’s resource base,
• land access risks,
• sovereign risks,
• risks associated with project construction and commissioning,
Australian Mineral Economics
• mining and processing risks,
• risks associated with the project’s supporting infrastructure,
• financial and marketing risks,
• management and industrial risks,
• environmental risks, and
• project specific risks.
The following discussion reviews several of these in more
detail.
Risks associated with the project’s resource base
The resources drive our projects and our
resources are driven by geology, the resource
models we generate should therefore also be
driven by geology rather than geostatistics.
Understanding the strengths and weaknesses of a
resource model is fundamental to understanding
a project well (Rozman, 1998).
A project’s estimated mineral resource are only an estimate.
Not only are there interpretive errors in assessing the continuity,
geology and structure, but there will also be variability in the
assay data, sample density assessment, the surveying of the
sample points and allocation of areas of influence. After any
calculation of mineral resources the professional carrying out the
feasibility study must be assured that it is the right order of
magnitude prior to assessing ore reserves, or have a good
understanding of the risks in this area.
It is important to use common sense and experience and
understand orders of accuracy when one is assessing quantitative risk.
The risks associated with the resource halo include:
• reliability of the base data;
• surveying,
• sampling,
• assaying,
• density determination;
• deposit continuity;
• grade variability;
• lower than predicted grades;
• density variability within and across geological subsets; and
• geological interpretation.
Mining and processing risks
Mining risks are associated with:
• mining methods and equipment sizing,
• ground conditions,
• strip ratios,
• mining ore losses,
• mining ore dilution,
• fixed plant and equipment,
• environmental matters, and
• unexpected cost pattern changes and equipment replacement
timing during the mine life.
Feasibility studies involve conceiving the most practical
mining system, mine layouts and production schedules, the
treatment process and the marketing possibilities for the
products. It is not possible to complete in any sensible way
studies for mineral production independent of mine design,
production scheduling and through these, ore reserves.
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Ground conditions including jointing, faults, areas of shear,
stress directions, deposit geometry, weathering conditions, zones
of secondary enrichment and water flow may dictate the use of
specific mining methods and selected equipment size should be
evaluated for risk.
Drilling, costeaning and other exploration activities may
provide valuable information that will assist in evaluating these
risks. The field geologists should record any potentially useful
information and early involvement of mining and metallurgical
personnel during the exploration will aid this process. All such
information should be available to the technical team
undertaking the feasibility study.
Processing risks can be associated with:
• treatment methods and equipment sizing,
• unexpected ore conditions,
• changed crushing and grinding conditions,
• reduced recoveries,
• increased reagent utilisation,
• increased plant wear and maintenance,
• unexpected contaminants,
• tailings disposal problems,
• treatment water problems, and
• waste water disposal.
Metallurgical risk assessment will generally require bench
scale and possibly larger scale tests on drill core and bulk sample
material. These will generally provide basic plant design criteria.
It is important to assess the risk of failing to achieve those
criteria when the project is in production, together with what
contingent plans can be initiated to eliminate or reduce the
effects on the project’s return.
Project design and construction risks
The design, construction and commissioning phase includes the
detailed mine planning, metallurgical planning and detailed
engineering design. From this follows procurement of
equipment, the engineering construction, mine development and
the crew training and project commissioning and fine-tuning.
Project construction risks may be associated with:
• access (sovereign and land title);
• infrastructure;
• construction manning and availability of skilled labour;
• project management (coordination, procurement, budgetary
control, time management and control);
• environmental;
• sociological;
• technical (electrical, mechanical, civil, mining and metallurgical
design); and
• poor cost estimates and cost over runs.
The definitive cost estimates and supporting time estimates
require inclusion of assessments of project risks and measures to
cater for such risks.
High quality management, construction coordination and tight
cost control should control project risk.
Time slippage during construction is a major risk in many
projects. Such slippage results in delayed commencement of
production with associated delays in commencement of positive
cash flow. Such slippages usually result in increases in capital
costs, compounding the financial losses.
124
Financial and marketing risks
There are many factors, as well as cost inflation, that both
directly and indirectly influence capital costs during construction
and can influence the operating costs once the mining and
processing are in production. Also, there are many uncertainties
in the prediction of commodity prices, commodity escalation
rates and exchange rates.
These may include:
Capital costs
• Cost over runs,
• key component delivery delays,
• unforseen costs (meant to be covered by the contingency),
• government policy changes,
• industrial delays or excessive allowance claims,
• key component failures during installation, and
• unexpected litigation.
Operating costs
• Cost over runs,
• unforseen costs due to unplanned events,
• unforseen government charges,
• unexpected industrial delays,
• unexpected plant and equipment failures,
• unexpected high interest rates on borrowed funds, and
• unexpected inflation.
Commodity prices
• Unexpected commodity price falls,
• unrealistic market size predictions,
• unexpected contaminant penalties,
• unexpected currency parity changes,
• unexpected changes in product transportation costs, and
• unforseen political and social factors affecting the markets.
The risk of failing to achieve those criteria assumed in the
financial modelling, when the project is in production, must be
assessed together with what contingent plans can be put in place,
including forward sales, to control the effects on the project’s
sales returns.
Project sensitivities
It is important to identify project risks and discuss their
satisfactorily mitigation, especially in areas of high project
sensitivity, in all relevant areas of the feasibility study reports.
Sensitivity analysis is not about adjusting a number of
supposedly key variables up or down by ten percent, one at a
time and tracking the change in the end financial result. The real
world is never that simple. Variables do not change one at a time,
nor are they limited to ten per cent movements. This kind of
‘analysis’ tends to show the obvious, that mining projects are
sensitive to exchange rates, product prices, levels of capital
expenditure and the like. Astute market practitioners and
participants do not need to be told this. They intuitively
recognise the sensitive areas of a project.
Stirzaker (1997) notes that another limitation to sensitivity
analysis is that it can only deal with the variables, which have
already been, identified as having an impact on the financial
viability of the project. It will not pick up factors that are not
included in the financial model.
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 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES
Using Monte Carlo simulations has become a widely used tool
to assist in the assessment of risk in mining projects. The
following two quotations highlight its use in feasibility studies.
In addition to the normal project-based cash flow
analysis, advanced Monte Carlo risk analysis
techniques are increasingly being used to assess
the downside risk and the upside potential of
projects. This has the advantage of minimising
the inherent bias that may be allowed to creep
into the study, and leads to a far better
understanding of the project (Laird, 1997).
The use of computers provides the opportunity
for iterative analysis of resource projects,
allowing the sensitivity of projects to be rapidly
and easily estimated. Monte Carlo style
probabilistic analysis is a computerised
technique, which can be effectively used to model
and subsequently represent the financial and
production permutations likely to result from a
resource project. The use of probabilistic
analysis is recommended and as a further check,
forces the user to thoroughly assess the strengths
and weaknesses of the data compiled for use in
the analysis of a project (Rozman, 1998).
Managing risk
It is important to be proactive in managing risk in all projects and
directing this toward areas of greatest risk potential and
magnitude. Assessment must be of whether there is a risk of a
gradual problem or a sudden problem, the nature, extent and
possible chain effect of the problem on other areas and the
magnitude of the effect of the problem on the overall project.
A valuable tool to aid seeing and understanding of risk is to
prepare a risk assessment and management spreadsheet or chart.
This should catalogue and rank the risks from those of greatest to
those of minimum influence together with a summary column of
possible contingent actions to control or minimise potential
influences on the project. Matters of safety, environment,
production and cost should be incorporated into the chart to
provide management with a clear overview of the risk situation.
Assessing the technical and financial viability of a mining
project requires consideration of risks involved in bringing a
mineral deposit into production and maintaining that production
during the planned life. Sensitivities can be applied to quantify
the effects of ‘what ifs’ on the project viability, but risk
assessment requires the input of competent professionals in their
areas of project expertise. These include geologists, mining
engineers, metallurgists, commodity traders and financiers.
Effective risk analysis is required to allow the building into a
project the flexibility and means to handle both anticipated
problems and the unexpected occurrences. It can usually be built
into the project planning at relatively minor cost during the
feasibility phase but may require major expenditure and
production losses during production.
MANAGING THE FEASIBILITY STUDY PROCESS
Because the feasibility study process can cost up to a ten per cent
of the overall project cost, it should be scoped and managed with
the same care as the project. Most importantly a poorly managed
feasibility study can lead to the wrong development decision.
The feasibility study is one of the early activities in a project. It
requires the employment and coordination of a team of multi-
disciplined competent professionals having complimentary skills.
Northcote (1998) notes that:
Feasibility studies are themselves of similar
structure to projects and therefore project
management techniques can be applied.
Australian Mineral Economics
His paper covers the scoping, management and co-ordination
of the feasibility process and discusses the allocation and control
of responsibility, time, budget and the study quality.
The first step in the preparation of any feasibility study is to
prepare a clear scope of work to be carried out, orders of accuracy
to be reached, time schedules for that work, a responsibility chart
for personnel responsible for the various areas in the study. The
procedure of pulling all sections together, controlling areas of
overlap and liaison should be the responsibility of a project
coordination team under the project manager.
FEASIBILITY STUDY REPORTS
A feasibility study report should provide an overview of the
project, all key facts of the project and present a logical and
workable scheme for its development and exploitation. The
project’s various advantages, risks, capital cost and its financial
returns should be clearly and openly discussed.
To achieve best practice, a feasibility study report must be a
clearly written stand-alone document enhanced by meaningful
pertinent diagrams. It must fairly summarise all key data, test
results, listings of resources, and technical, legal tenure and
environmental consents and financial matters that are pertinent to
the development of the project. However, there should not be
excessive amounts of data included in the main body of the
report as these both confuse the reader and detract from the
thrust of the report. Relevant listings of data can be included in
supporting appendices.
Information on the different methodologies utilised to estimate
of the project’s ore reserves, production schedules, cash flow
assessments and valuations together with comment on base data
reliability will aid the reader’s understanding and evaluation of
the project.
The report must be written with the objective of disclosing
assumptions made about the inclusion of any inferred resources
or ‘blue sky’ ore in the production schedule including applied
probability factors and other factors that have significant
influence on the valuation.
Reference to both upside and down side valuation must be
included such that the reader understands the projects
sensitivities, potential risks and the most likely valuation. The
reader must understand the project’s sensitivity to changes in
recoveries, dilution, exchange rates, commodity prices costs and
the many other factors likely to cause variation in the valuation
during the planned operating life of the project; such that he may
be able to either accept the study recommendations or make a
modified judgement.
REFERENCES
Amos, Q G, 1998. Resources and risk – the lender’s view, in Proceedings
Ore Reserves and Finance Seminar, pp 57-64 (The Australasian
Institute of Mining and Metallurgy: Melbourne).
Butler, P, 1994. A banker’s view of cash flow methods in mineral valuation,
in Proceedings Mineral Valuation Methodologies 1994, pp 47-62 (The
Australasian Institute of Mining and Metallurgy: Melbourne).
Christie, M A, 1997. Orebody definition and optimisation, in Proceedings
Mindev ‘97, pp 47-56 (The Australasian Institute of Mining and
Metallurgy: Melbourne).
Cusworth, N, 1993. Predevelopment, in Cost Estimation Handbook for
the Australian Mining Industry, (eds: M Noakes and T Lanz) pp
252-259 (The Australasian Institute of Mining and Metallurgy:
Melbourne).
Gilfillan, J F, 1998. Testing the data – the role of technical due diligence,
in Proceedings Ore Reserves and Finance Seminar, pp 33-42 (The
Australasian Institute of Mining and Metallurgy: Melbourne).
JORC, 2004. Australasian Code for Reporting of Mineral Resources and
Ore Reserves (The JORC Code), The Joint Ore Reserves Committee
of The Australasian Institute of Mining and Metallurgy, Australian
Institute of Geoscientists and Minerals Council of Australia. [Online].
Available from: <http://www.ausimm.com/codes/jorc0105.pdf>. Date
accessed: 8 May 2006.
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CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES

Laird, A M, 1997. How to develop a project, in Proceedings Mindev ‘97, 5. Geology

pp 3-8 (The Australasian Institute of Mining and Metallurgy:
Melbourne). Brief history of previous exploration and production in the
Northcote, A E A, 1998. Scoping of feasibility studies, in Proceedings immediate project area;
The AusIMM Annual Conference ‘98, pp 105-110 (The Australasian
Institute of Mining and Metallurgy: Melbourne). exploration carried out including geophysical and
Rozman, L I, 1998. Measuring and managing the risk in resources and geochemical surveys, drilling, sampling, logging;
reserves, in Proceedings Ore Reserves and Finance Seminar, pp 43-56 regional and detailed deposit geology and deposit
(The Australasian Institute of Mining and Metallurgy: Melbourne). mineralogy, together with supporting diagrams and maps;
Seymour, C, 1998. Risk analysis in open pit mine planning, in
Proceedings The AusIMM Annual Conference ‘98, pp 129-134 (The mineral resources including a summary of the evaluation
Australasian Institute of Mining and Metallurgy: Melbourne). methodology;
Shillabeer, J H, 1998. Lessons learned preparing mining feasibility studies, the potential for the discovery of additional mineral
in Proceedings The AusIMM Annual Conference ‘98, pp 111-115 (The resources within the tenements; and
Australasian Institute of Mining and Metallurgy: Melbourne).
Stirzaker, M, 1997. Feasibility studies – Risks and sensitivities, in mineralogy of the ore and comments on the foot wall,
Proceedings Mindev ‘97, pp 35-37 (The Australasian Institute of hanging wall and surrounding country rock.
Mining and Metallurgy: Melbourne).
VALMIN, 2005. Code for the Technical Assessment and Valuation of 6. Mining
Mineral and Petroleum Assets and Securities for Independent Expert
Reports (The VALMIN Code), The VALMIN Committee, a joint Brief mining overview;
committee of The Australasian Institute of Mining and Metallurgy,
the Australian Institute of Geoscientists and the Mineral Industry mining conditions and methods;
Consultants Association (The Australasian Institute of Mining and mine design criteria including recovery and dilution;
Metallurgy). [Online]. Available from: <http://www.ausimm.com/
codes/valmin_2005.pdf>. Date accessed: 8 May 2006. ore reserves (include proposed mining methods and general
White, M E, 1997. Feasibility studies – scope and accuracy, in economic parameters assumed in planning their mining);
Proceedings Mindev ‘97, pp 27-34 (The Australasian Institute of
Mining and Metallurgy: Melbourne).
planned production schedule and the probability of these
being achieved when they exceed the ore reserves;
Yeates, G and Adams, M H, 1998. Resource and reserve reporting for BHP
Cannington, in Proceedings Ore Reserves and Finance Seminar, pp geotechnical considerations;
19-27 (The Australasian Institute of Mining and Metallurgy:
Melbourne). access;
development schedule;
APPENDIX – CHECKLIST OF THE MAIN mine plan and schedule;
SECTIONS OF FEASIBILITY STUDY REPORTS equipment including support for selection and availability;
The list below is a checklist of the main sections of a feasibility staffing, manning and rosters;
study reports. It will require modification to make it project
mine services – water, power, communications, explosives,
specific.
compressed air, ventilation;
mine waste and overburden disposal;
1. Introduction
dump and mine area refoliation;
Scope of the report; and
other project specific matters;
simple introduction to the project covering its location,
topography, climate, land use and access to the area. environmental matters; and
areas of potential risk and advantage.
2. Summary
Summary description of the key points of the project;
7. Treatment
areas of predevelopment requiring further investigation or Brief treatment overview;
evaluation; process selection and route;
the anticipated project financial situation; testwork;
summary of the reports conclusions; facility capacity criteria;
recommendation of whether or not to proceed with the facility design and quality criteria;
development of the project; and
process design and operational features;
summary of project risks and opportunities.
layout;

3. Tenements and ownership equipment sizes and specifications;

Summary of the tenements, equity holders and parties
having any interest in the project; and
if possible tenement location plans should be included.
4. Location
Information on the location, access, nature of the site, any
special requirements or unusual conditions;
facility control;
staffing, manning and rosters;
services – power, water, sewerage, communications, fire,
waste disposal;
materials – foundations and construction material sources;
tailings disposal and eventual refoliation;
tailings water recovery and surplus water disposal;

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 CHAPTER 11: PRELIMINARY, PREFEASIBILITY AND FEASIBILITY STUDIES

other project specific matters; air,

environmental matters; and land use and rights of other parties to land,
areas of potential risk and advantage. impact assessment,
mitigation proposals,
8. Project infrastructure socio-economic impacts,
Roads, other project specific matters,
drainage, environmental matters, and
sewerage disposal, areas of potential risk and advantage.
water supply,
power supply, 11. Project development and management
communications, Construction sequence;
transport, contracting strategy;
warehousing, project structure and organisation;
mobile equipment, time and expenditure schedules;
spare parts, schedule of changing workforce (size, type and source);
maintenance equipment, planning and engineering design;
administration buildings, staffing;
laboratory, industrial relations matters of significance and site awards;
staffing, manning and rosters, temporary infrastructure requirements (power, other services
accommodation);
services,
project management, coordination and administration
accommodation, (procurement, time and cost control);
other project specific matters, recruitment and training of operating personnel;
environmental matters, commissioning and hand over;
areas of potential risk and advantage, fine tuning at start of operations;
temporary services, and safety and security matters;
temporary accommodation. environmental matters; and
areas of potential risk and advantage.
9. Offsite infrastructure
Roads, 12. Operations
rail, Structure,
air, workforce – size, type and source,
power, rosters,
communications, employee relations,
water, recruitment and selection,
workforce accommodation, administration,
export facility, accommodation,
logistics and transport, training,
staffing manning and rosters, availability, and
other project specific matters, cost rates.
environmental matters, and
areas of potential risk and advantage. 13. Capital and operating costs
assumptions (exchange rates, escalation, etc),
10. Environmental financial over view of project,
Climate and meteorology, methodology,
terrain, contingency and accuracy,
flora, capital costs:
fauna, basis,
surface water, exchange rates,
ground water, owner costs to establish,
acoustic, preproduction development,

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engineering, procurement and construction supervision: marketing risks and contingent action,
plant and equipment, market strategy and implementation, and
infrastructure, revenue forecasts.
equipment building materials,
construction labour, 15. Project risks and opportunities
transport, Mineral resources, ore reserves and geological,
indirect costs, land rights,
government fees and charges, sovereign and social,
administration, mining,
owner project direct and indirect costs, treatment,
insurances, other technical,
commissioning, other operating,
working capital including first fill and insurance spares, environmental,
capital cost risks and contingent action, construction,
operating costs: commissioning,
basis, marketing risks,
operating spares, financial,
labour, areas of cumulative risk and possible contingent actions, and
consumables, areas of catastrophic risk and possible contingent actions.
replacement capital,
government royalties and levies,
16. Financial evaluation
administration, Basis of evaluation,
marketing, assumptions,
transport, economic evaluation and model,
agent fees, sensitivity and risk factors,
insurances, cash flow, present values and pay back periods, and
rehabilitation, and financial conclusions.
operating cost risks and contingent action.
17. Conclusions and recommendations
14. Marketing Overall study conclusions,
Commodity specification, recommendations as to the next stages of activity,
current market demand and sources, overall costs and times to carry out the recommendations,
supply demand and price forecasts, timing to achieve recommendations, and
quality control and criteria, major risks, sensitivities and areas of project advantage.

128 Australian Mineral Economics

 CHAPTER 12

Mineral Project Evaluation — Dealing with

Uncertainty and Risk
Pietro Guj

Introduction: Beyond DCF/NPV Analysis

Attitudes to Risk – From Expected Value to Expected Preference Value (Certainty Equivalents)
and Pricing of Risky Projects
Risk Spreading Through Joint Ventures
Bayesian Decision Trees and Progressive Risk and Value Analysis
Modern Asset Pricing (MAP) Using Commodity Forward Prices
From Static DCF/NPV to Dynamic Real Option Valuations (ROV)
Using Binomial Lattices in Valuing Real Options in Practice
Valuing an Expansion Option with the Binomial Lattice Method Using the ‘Risk-Free Probability’
Valuing Tonnage-Grade Trade-Offs
Evaluating the Sequential and Compound Real Option Value of Mineral Exploration Farm-In/
Options Agreements
Strategic ROV Considerations
Conclusions

INTRODUCTION: BEYOND DCF/NPV ANALYSIS
Much of Chapter 10 dealt with evaluations under assumptions of
certainty. However, the only thing one can be certain about is that
virtually all the estimates of inputs are in fact uncertain and they
will not occur at the estimated level as the project evolves.
More often than not, the performance of a project is very
sensitive and deeply affected by the volatility of critical inputs.
Yet it may still be quite attractive to invest in a project that
incorporates a number of uncertain inputs, provided the project is
designed to anticipate likely eventualities and appropriate
risk-management strategies are in place, recognising that project
performance is not static, as the deterministic nature of standard
DCF analysis would imply.
A decision to invest in a project based exclusively on
DCF/NPV would imply that the investor is inflexibly committed
to the project plan, irrespective of unfolding future events. Very
few projects evolve strictly according to plans.
Managers can generally react to events, whether anticipated or
not and modify their action in such a manner as to minimise the
impact of uncertainty or risk. The science of anticipating and
planning strategies to alleviate or even neutralise the potentially
negative impacts of uncertain events is known as risk
management. The extent to which investors manage risk is a
function of their individual or corporate risk tolerance and
related attitude to risk, which is typically strongly influenced
by their level of wealth.
Discussion in this chapter will explore how static DCF
valuations, backing risk-neutral investment decisions based on
expected monetary value (EMV), can be analysed and modified
to account for individual risk-aversion, generating risk-adjusted
or certainty equivalent (Cx) measures of value.
The transfer of option valuation methodologies from the field
of financial derivatives to that of real options inherent in many
tangible but risky resources projects will be further addressed.
This is an area of rapid and exciting development in the field of
project evaluation.
ATTITUDES TO RISK – FROM EXPECTED
VALUE TO EXPECTED PREFERENCE VALUE
(CERTAINTY EQUIVALENTS) AND PRICING OF
RISKY PROJECTS
Understanding the nature of risk and risk-neutral
expected returns
In Chapter 10, sensitivity and scenario analyses were used to
identify and quantify those input variables to which the
performance of the discounted cash flow mine model of Table

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CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
10.1 was most sensitive. A Monte Carlo simulation was then
applied to produce its:
• expected monetary value (EMV) (ie NPV = $12.89 million).
This represents the mean of the distribution or the sum of all
possible NPV values weighted by their respective probability
of occurrence, ie:
Mean = Σ n i= 0 (x i * p i )
• and risk, as measured by the standard deviation around this
mean (ie $8.98 million), the relevant formula is:
Standard deviation = [ Σ n i= 0 (x i − mean)2 * p i ]0 .5
• defining the probability distribution of all possible net
present values under the probabilistic input assumptions used
in the Monte Carlo simulation.
Similarly, the expected value of a game of tossing a fair coin,
where the bank pays $2 if a head (H) comes up and where the
gambler pays $1 if a tail (T) comes up is, from the point of view
of the gambler:
EMV = 50% * $2 + 50% * (-$1) = $0.50
or an expected return = $0.5/$1 = 50%
In this case, the discrete classical or objective probability of
these two events are known to be (p(H) = p(T) = 50 per cent),
which are mutually exclusive and collectively exhaustive. No
other event can happen and therefore their cumulative probability
of occurrence must be one. While there is an expectation that, on
balance, one would win $0.5, there is nonetheless a reasonably
high chance of losing $1 in each trial.
In finance, risk is defined with reference to expectations. It has
both an upside and a downside, which includes, but is not limited
to, risk in its colloquially accepted meaning as the chance of
making a monetary loss.
On the basis of the expected return on each dollar invested, the
game represents a good investment opportunity. No one would
have any hesitation in investing in it. This, at least, would be the
case provided there were no competitors offering a similar game
with a higher EMV, (say one that paid $4 instead of $2 for the
same $1 bet, ie with an EMV of $1.50).
It is common to have to choose between, say two mutually
exclusive exploration projects, such as:
• project A, which has a potential gross value of $105 million
with a ten per cent probability of discovery and an
exploration cost of $5 million; and
• project B which has a potential gross value of $70 million
with an 80 per cent probability of discovery and an
exploration cost of $40 million.
Their respective expected monetary values (EMVs) are:
• EMV(A) = 0.1 * ($105 M - $5 M) + 0.9 * (-$5 M) = $5.5 M; and
• EMV(B) = 0.8 * ($70 M - $40 M) + 0.2 * (-$40 M) = $16 M.
Rational investors are wealth maximisers. Using a strictly
risk-neutral criterion (ie if they were indifferent to the different
risk exposure inherent in the two projects) they would select the
project with the highest EMV – that is project B. But let us now
assume that exploration on project A leads to an improvement in
its chance of discovery from ten per cent to 20 cent. The EMV of
project A now becomes:
• EMV(A) = 0.2 * ($105 M - $5 M) + 0.8 * (-$5 M) = $16 M.
130
Risk-neutral investors should now be, in theory, indifferent
between project A and B because they have the same EMV of
$16 million, irrespective of their different risk characteristics.
Project A has a lower chance of a higher return, but a higher
chance of a lower loss than B and vice versa. Risk-neutral
investors would not differentiate between investing in a larger
number of type-A projects or in a lower number of type-B ones,
as long as they have the same expectation of an EMV of $16
million.
Such an attitude, however, seems unrealistic in real life. The
choice becomes more complex because investors are not
indifferent to the underlying risk exposure and are generally
risk-averse.
From risk-neutral to risk-averse investment
decisions
Returning to the coin-tossing game, its expected return would
still be 50 per cent if the wagers were to be progressively
increased to:
• $200 and -$100,
• $2000 and -$1000,
• $20 000 and -$10 000,
• $20 million and -$10 million, and so on.
However, as the wagers rise relative to an investor’s wealth,
their attitude will soon swing from risk-neutral to risk-averse.
This happens because, as capital at risk as a proportion of wealth
increases, they become increasingly sensitive to exposure to the
risk of gambler’s ruin.
Consider an exploration company with a budget of $1 million
embarking in a series of projects costing $0.2 million each in a
geological terrain with a mineral endowment which results in ten
per cent chance of success in each trial (PS). The company is in a
position of withstanding five successive failures, after which it
will go out of business.
A discrete probability distribution of mutually exclusive events
of the type success and failure is the binomial distribution:
Probability of x successes in n trials = Pxn = (C nx ) + Px *(1 − P)n − x
where:
PS = probability of success in any trial
n
(C ) = n!/[x!*(n-x)!],
x
where:
n! = 1*2…*n and
0! =1
Hence, the probability of survival, ie of at least one success
in five trials (P15 ) will be the sum of the probabilities of:
• one discovery in five trials, a reasonably likely event, plus
• two discoveries in five trials, plus
• three discoveries in five trials, plus
• four discoveries in five trials, plus
• five discoveries in five trials, a most unlikely event.
Thus:
P15 = [5!/(1!*4!)]*0.1*0.94 + [5!/(2!*3!)]*0.12*0.93 +
…+[5!/(4!*1!)]*0.14*0.9 = 0.4099 or 40.99 per cent
A similar figure could have been obtained by using the
continuous exponential approximation of the binomial
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 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

distribution, ie Pxn = 1 - e-nPs or P15 = 1 - exp(-5*0.1) = 1 - 0.6065 2. What is the maximum loss that could be experienced with a
= 0.3935 or 39.35 per cent. one per cent probability (or the VaR at one per cent) if the
As a consequence the probability of gambler’s ruin, ie company selection of exploration projects proves poor?
1 minus the probability of at least one success in five trials (P15 ) =
1- 0.4099 = 0.5901 or 59 per cent. It is a straightforward exercise to answer these questions
either:
Clearly the company would have food for thought and ask
themselves whether they are in the right game. • with the help of the standard normal distribution or z tables, or
If anything, this estimate of the probability of failure is • by drawing the distribution using a personal computer
conservative because it is based on the inherent assumption that spreadsheet as shown in Figure 12.1.
the probability of discovery in a single trial does not decrease
with successive discoveries, this is equivalent to exploring in a
terrain with a very large pool of undiscovered orebodies or
statistically sampling with replacement.
A better approximation could be obtained using a hyper
geometric distribution, provided one could estimate the rate at
which the initial probability of discovery in each trial decreases
with each successive discovery as the area matures, ie sampling
without replacement.
These statistics naturally do not take into account any
‘learning’ effects from both one’s own and others’ successes and
failures influencing the probability of success (and its perception
in explorers’ minds) in successive trials.
The magnitude of the potential adverse consequences of a
downside outcome multiplied by its probability of occurrence
represents the severity of the impact of the risk to which one
would be exposed when embarking into any uncertain venture.
Any company should seriously assess the corporate consequences
of such an impact in establishing a sound risk management FIG 12.1 - Calculation of value at risk.
policy to determine their future strategies in line with a level of
risk exposure acceptable to their shareholders. The $80 million point in the normal distribution rests at a
value of z = µ/σ = (30 per cent * $90 M) / (40 per cent * $90 M)
If the project is already one of their assets they can:
= 0.75. As can be seen in Figure 12.1, 15.20 per cent of the area
• sell it to a party better equipped to handle its risk; or under the curve falls to the left of z = 0.75 or of $80 M, ie there
• spread the risk by farming out some equity through a joint is a 15.20 per cent chance of losing more than $10 million or an
venture. 84.80 per cent probability that at the end of the year the asset
will be worth $80 million or more.
If, on the other hand, the project represents a new investment
opportunity they can: To determine the VaR at one per cent one follows the reverse
process, calculating the z value that corresponds to an area of 0.5
• bear the risk; – 0.01 = 0.49 under the standard normal density curve. This z
• hedge or insure against elements of it, if possible; value is 2.333. Hence the cut-off value will be:
• shift some of the risk to another party through contractual
arrangements; $117 M – 2.333 * $36 M = $33.012 M
• spread the risk by farming in at a level of equity lower than
100 per cent by means of a joint venture; or This means that there is a one per cent probability that up to
• reject the project. $33.012 M are at risk, or conversely, at the end of the year it is
expected that the asset will be worth $56.988 million (ie $90 M -
Risk exposure and value at risk (VaR) $33.012 M) or more with a 99 per cent level of confidence.
Modern risk exposure policy makes use of a measure called Applying VaR to a security portfolio entails estimating the
value at risk (VaR). Value at Risk is the worst loss that is mean and variability of the returns on each asset and constructing
possible under normal market conditions on any asset during a a computationally intensive variance-covariance matrix. A more
given period at a given level of confidence, eg VaR at one per practical alternative approach to determine the value at risk of a
cent. The longer the period under consideration the greater the portfolio of exploration and mining projects is to run a Monte
VaR becomes. Carlo simulation of all the projects simultaneously and
The concept of VaR is clearly discussed in Benninga (2000, determining their collective expected value and surrounding
pp 209-215) who provides both the basis of how to calculate VaR distributions of possible aggregated outcomes, taking into
for a single asset, and of how this can be extended to the primary consideration any significant level of correlation among the
use of VaR in managing a portfolio of various projects/investments inputs of various projects. This type of analysis, which is
with different risk characteristics. common in the treasury functions of banks and other financial
Suppose the possible returns on an exploration company institutions, is currently being adapted by some of the major
currently capitalised at $90 million are normally distributed and mining houses as a strategic planning tool.
that, on the basis of past performance, its capitalisation is
expected to grow on average by µ = 30 per cent but within a Risk preferences and the price of risky
standard deviation of σ = 40 per cent per annum. One might investment opportunities
wonder:
The level of risk-aversion varies from investor to investor as a
1. What is the probability of a loss of more than $10 million
function of:
by the end of the year? That is, that the capitalisation of the
company will be less than $80 million. • their individual wealth/risk capital; and

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CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

• other individual or corporate traits that are a function of The best practical example of a certainty equivalent in the
the culture of the organisation, its management and past context of mining is the forward contract price for a
risk-exposure experiences. commodity. The binding nature of forward sale contracts means
that the seller will receive the exact agreed forward amount at
It is possible to overcome the shortfalls of using the expected maturity with certainty thus neutralising any price risk. This can
value criterion (ie assuming risk-neutrality) in risky investment be stated as:
decisions by using the ‘utility’ function. This function, unique to
each investor, captures the way he or she assesses the inherent
risk characteristics of a project, ie their risk-aversion. C x = − RT ln{Σ n i = 1 pi e − xi / RT }
Most utility functions in modern decision analysis are
exponential and, if the payoff is desirable, ie to be maximised, where:
take the form:
pi is the probability of outcome i
xi is the value of outcome I
u(x) = 1 - e-x/RT
n is the total number of possible outcomes
where: For example, if the firm has a risk tolerance coefficient (RT) of
$100 million, the certainty equivalent value (Cx (A)) of project A is:
RT is the risk tolerance coefficient
Cx (A) = -$100 M * ln(0.2 * e-$100 M/100 + 0.8 * e$5 M/100) = -100 M
x is the monetary payoff1 variable
* ln(0.073576 + 0.841016) = -100 M * (-0.089277) = $8.9277 M
e = 2.7182818 is the exponential constant
A value of $11.54 million can be obtained for project B in a
It is normal practice to scale risk profile curves in such a similar manner. Thus, if the firm had a RT of $100 million, it would
manner that the utility value on the y-axis, as in Figure 12.2, select project B because its Cx value at $11.54 million is higher than
ranges between –1 and 1. that of A at $8.93 million (Figure 12.3), even though the expected
values of these two projects are the same at $16 million.
0.2 $M
Mineral Discovery A
$100
Explore Project A $105 $100
1 0.63
-$5 $8.93 0.8
0.8 0.09 Barren
Progressive wins -$5
0.6 do not feel as $0 -$5
2 The CE of Project B is -0.05
0.4 good….. 11.54 higher than that of A 0.8
Utility Value

0.11 Mineral Discovery B

0.2 $30

0 Explore Project B $70 $30

0.26
-10 -5 0 5 10 15 20 25 -$40 $11.54 0.2
-0.2 0.11 Barren
-$40
-0.4 $0 -$40
…as losses feel
-0.6 bad as one
Risk Tolerance Coefficient RT = $100 -0.49

-0.8 approaches A risk-averse investor would prefere to invest in Project B because its has
Gambler's Ruin a higher certainty equivalent (i.e. $ 11.54M) than that of Project A (i.e. $ 8.93M)
-1 given his RT of $ 100M, even though their expected value is the same ($ 16M)
Monetary payoff
FIG 12.3 - Risk-averse comparison of certainty equivalent values
Exponential Utility Function
of projects A and B.

FIG 12.2 - A typical risk profile curve for an investor or firm.
Risk-neutrality, ie a straight line, is only approximated for
relatively small potential losses and gains beyond which
risk-aversion rapidly sets in. Indeed the utility function is highly
concave to the pay-off or x axis.
You could say that a win does not feel as good as the loss of an
equivalent amount feels bad. This is particularly so, after a series
of consecutive losses, as one approaches one’s venture capital
limit and the likelihood and fear of gambler’s ruin increases. In
the example a loss of -5 has a utility value of around -0.95,
roughly double that of a win of a similar magnitude of +5.
The individual risk tolerance coefficient (RT) is also the main
determinant of the selling price at which the holder of a risky
project would be prepared to divest, in exchange for secure cash
in hand. This secure cash price represents the ‘certainty
equivalent (Cx)’ of the otherwise uncertain expected value of the
project.
1. If the payoff is undesirable, ie must be minimised, then the utility
function takes the form: u(x) = 1 - ex/RT
At an RT of $100 million the company would be indifferent
between selling project B for any price in excess of $11.54
million, or attempting to achieve its EMV of $16 million. They
would view the potential net success value of $30 million as
desirable even though it comes with a smaller, but still significant
chance of losing $40 million.
It is worth noting from Figure 12.4 that investors with risk
tolerances (RTs) lower than about $40 million would still value
both projects for sale at a minimum of around $3.5 million even
though they would not be in a position to invest in project B. At
RTs lower than $40 million project A becomes more valuable
until at a RT of around $33 million the Cx of project B becomes
negative followed by project A at a RT of around $22 million.
The fact that investors with different levels of risk-aversion
will value the same project differently creates a potentially
significant range of acceptable negotiating prices. These range
between a floor set by the more risk-averse company and a cap
reflecting the preferences of the less risk-averse one. For this
reason deals are often perceived as win-win.
Aside from risk, project size is another major strategic
consideration in the determination of the price that major
companies, finding it hard to maintain a growth rate acceptable
to their shareholders, are prepared to pay for a project. As a

132 Australian Mineral Economics

 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

10.00
10

5.00
Certainty Equivalent (Cx)

Cx $M
0.00
0 0% 20% 40% 60% 80% 100%
0 20 40 60 80 100 -5.00

-5 -10.00
% JV Equity
-10
Risk Tolerance Coefficient (RT) Cx $M

Project A
FIG 12.4 - The sensitivity of certainty equivalents (Cx) to
risk tolerance coefficients (RT).
result of these considerations and a host of other strategic
objectives, projects of different size and with different levels of
underlying risk (irrespective of their potential up-side value) tend
to get in the hands of companies of appropriate size to handle
them. Schodde (2005) calls these ‘natural project owners’.
This dichotomy, of course, is in some ways inconsistent with
the notion of a single fair market value as espoused by the
VALMIN code (2005), as the fairness of the price relates to
individual risk profiles.
Thus, the expected preference value rule is for any value of RT
to select the investment with the highest certainty equivalent Cx.
An empirical approximation of the risk tolerance coefficient
(RT) is twice the maximum bet that an individual or a
corporation would be prepared to place on the earlier game of
tossing a coin, generating benefits twice as large as the
corresponding costs with a probability of 50 per cent-50 per cent,
ie with an expected return of 50 per cent. This maximum bet can
generally be established through a structured interview process,
related Delphi techniques and crosschecking for consistency with
previous actual investments, all of which is far from
unambiguous.
RISK SPREADING THROUGH JOINT VENTURES
Different companies may wish to embark in joint ventures for a
variety of reasons. Besides budgetary and risk spreading, these
include tax minimisation and strategic commodity, geographical
and/or technological diversification.
A good application of certainty equivalents, in the context of
risk spreading, is in determining the equity participation
appropriate to companies with specific individual levels of risk
tolerance.
This can be illustrated by an example where a company with a
Project B
FIG 12.5 - Certainty equivalence as function of percentage joint
venture equity.
It peaks in value at about $5 million for equity levels of around
35 per cent. With this information, the company is now in a
better position to determine whether and to what level of equity
they should farm in this project.
Many companies have reasonably stringent policies as to the
minimum equity they are prepared to acquire in projects. Large
companies generally prefer in excess of 50 per cent with
management of the joint venture and resident status. In the
present example while positive, the value of acquiring majority
equity is sub-optimal compared to 35 per cent equity.
If one were to farm out 50 per cent of a risky project in
consideration of a commitment by the farming-in participant to
contribute 50 per cent of future expenditure, this would allow
exploration of two similar projects per unit of money invested
instead of only one. It does not follow, however, that such a
strategy would double the company’s cumulative chance of
discovery and therefore its survival.
This is because the cumulative probability of discovery (Pn)
adheres to a binomial distribution, which is not a linear function
of either the number of trials (n) or the probability of success in a
single trial (Ps). The non-linear nature of the change in the ratio
between the cumulative probability of discovery for 100 per cent
equity exploration and that for a double number of trials under a
50 per cent joint venture as a function of changing Ps is
emphasised if plotted on log-normal graph paper as in Figure
12.6 (modified after Burn, 1984, p 60).
The figure shows three companies, with exploration budgets of
$1 million, $2 million and $10 million respectively. Assuming
that the average cost of an exploration trial is $0.2 million, the
companies could either undertake five, ten or 50 exploration
projects respectively on a 100 per cent equity basis or ten, 20 or
exploration trial through 50%
Times chance of discovery is

RT of $100 million is offered an exploration project with 50 per 2

improved by doubling

cent probability of discovering an orebody worth $100 million 1.8

net of the exploration costs and 50 per cent probability of losing 1.6
$40 million in exploration.
JV

1.4
Although the expected monetary value (EMV) of this project
1.2
is $25 million, the corresponding certainty equivalent (Cx) is
-$8.29 million. As a consequence acquisition of 100 per cent of 1
the project is out of question. 0.0001 0.001 0.01 0.1 1
Probability of discovery in a single trial (Ps)
However, from Figure 12.5, which shows how the Cx varies as
a function of acquisition of progressively lower percentage P(10/5) P(20/10) P(100/50)
equity in the project, it can be observed that the Cx becomes
positive once the equity participation falls below 70 per cent.
FIG 12.6 - Joint venture risk trade-off.

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CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
100 projects on a 50 per cent joint venture basis. It can be
observed how the relevant ratios, eg P(10/5), P(20/10) and
P(100/50), are close to two only at relatively low levels of Ps. As
Ps increases the number of times by which joint venturing
increases the cumulative probability of discovery falls rapidly.
For instance at a probability of success (Ps) of ten per cent, the
cumulative probability of at least one discovery in ten trials is
0.6513. This is only 1.59 times as high as that on five trials, ie
0.4099.
For a Ps of ten per cent, the minimum expected value per dollar
invested for a target worth $50 million will be:
• an EMV (of 100 per cent exploration) = 0.4099 * $50 M +
0.5901 * (- $1 M) = $19.90 M; versus
• an EMV (of 50 per cent joint venture exploration) = 0.6513 *
$25 M + 0.3487 * (-$1 M) = $15.93 M.
These are the minimum EMVs, because 40.99 per cent and
65.13 per cent are the probabilities of at least one (not exactly
one) discovery in five and ten trials respectively. For a more
correct figure one would have to weight the probability of
exactly one discovery, exactly two discoveries and so on up to
five or ten trials respectively.
Thus, under the assumptions, to reduce the chance of
gambler’s ruin from 59.01 per cent to 34.87 per cent, one would
have to forego a minimum of $3.97 million (ie $19.90 M -
$15.93 M) in expected value. As for all forms of insurance or
hedging there is a cost to spreading risk through joint ventures.
It is obvious that, if the contributions to a joint venture costs
are to match a participant’s equity, the minimum loss of
expected return occurs on the more risky side of the
spectrum. Thus, under these conditions, there is a rationale for
farming out risky projects and for farming into as much
equity as possible in those with higher probability of success,
and farming into low-risk project justifies an adequate premium.
Projects of potential size and with lower risk of failure are also
likely to absorb most of the exploration investment capital
available in the market at any time. Those firms, which are less
subject to ‘capital rationing’ or which have ready access to equity
are most likely to undertake these expenditures.
BAYESIAN DECISION TREES AND
PROGRESSIVE RISK AND VALUE ANALYSIS
In exploration and mining projects successive probability events
and related decisions are generally dependent on one another or
Bayesian in nature. Bayesian, or dependent, probabilities
systems, as opposed to independent ones, can often lead to
counter-intuitive results.
Hayward (2003) considers the case of a new airborne
geophysical technique that, traverses and samples adjacent map
graticules in a systematic manners and generates ‘true’ anomalies
over 95 per cent of the map graticules containing a mineral
deposit, as well as ‘false’ anomalies over five per cent of the
barren map graticules it traverses. Thus, the probability of
getting a true anomaly given that a deposit is present (ie P(A/D))
is 0.95 and that of a false anomaly given that no deposit is
present, ie over barren terrain (ie P(A/no D) is only 0.05.
Because systematic pattern drilling in the region leads on
average to the discovery of one orebody for every thousand small
graticule blocks drilled, the probability of discovery without the
use of the new geophysical technique is P(D) = 0.001.
The question is by how much does the probability of discovery
increase if a geophysical survey is run on the tenements to
generate drilling targets, ie what is the probability of discovery
given an anomaly P(D/A)? Most geologists will intuitively tend
to guess that P(D/A) improves dramatically compared to P(D),
with many guessing probabilities higher than 50 per cent. In
reality the probability of discovery after the geophysical survey
134
generates an anomaly P(D/A) will increase from one per
thousand to 1.86 per cent, nowhere close to most people intuitive
estimate. This happens because P(D/A) is Bayesian, ie:
P(D/A) = P(D) * [P(A/D) / P(A)]
This relatively low level of improvement can be demonstrated
using the case of a geophysical survey covering 10 000 graticular
blocks as follows:
Because:
P(A) = P(A/D) + P(A/no D)
= (9.5 +499.5)/10 000
= 0.051
then:
P(D/A) = 0.001 * [0.95/0.015]
= 1.86%
The first impulse to rush to drill the most intense anomalies
would not be the best strategy. It may be better to run the
geophysical survey with a coarser detection threshold to reduce
the number of false anomalies. Hayward (2003) concludes that
the ‘best targeting parameter is not the one that captures the most
deposits’. One should also devise some alternative means of
quickly reducing the number of false anomalies through different
and unrelated exploration techniques and selection criteria.
Decision trees are useful tools to structure, display and analyse
project risk and returns in chronological sequential order. A
decision-tree consists of a sequence of:
• decision nodes (squares) or possible alternative actions at
various points in time which are under the control of and at
the discretion of management; and
• probability or event nodes (circles), which are subject to
chance (state of nature) and on which management has no
influence.
Contrary to DCF/NPV, which entails a single static decision of
the invest/reject type at the point of evaluation, decision trees are
dynamic in that they consider all the main possible future
decisions open to management following each relevant chance
event.
Thus a decision tree model values the effect of combinations
of probabilistic events.
Let us assume that it costs $250 000 for a geophysical survey,
which has a 50 per cent probability of outlining a target. Assume
also that an adequate delineation drilling program and feasibility
study, costing $5.5 million, in turn, has a five per cent probability
of leading to the discovery of a large orebody worth $400 million
and a 25 per cent probability of a small orebody worth $40
million. The owners of the project must also consider whether to
attract a joint venture participant to earn 50 per cent equity by
fully funding the drilling program.
By working out and rolling back the expected monetary
value of individual outcomes at each stage in the decision tree of
Figure 12.7, the owners can determine that, in their current
scenario and on a risk-neutral basis, the optimal decision is to
carry out the geophysical survey and drilling program in-house,
thus retaining 100 per cent equity in the project.
This decision would, however, tip over to carrying out the
reconnaissance in-house and then farming out the prospect if the
chance of success were to be perceived as lower and/or the
estimated cost of drilling as higher.
If the firm, however, had a limited exploration budget and was
risk-averse (eg had a risk tolerance coefficient RT of $100
million), certainty equivalent values could be substituted as
shown in Figure 12.8. Notice that, on a risk-averse basis, the
Australian Mineral Economics
 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

EXAMPLE OF EXPLORATION DECISION TREE TO DETERMINE WHETHER TO FARM OUT AT DRILLING STAGE
On a risk-neutral expected monetary value (EMV) basis the decision would be to drill the project out
0.05
Risk tolerance coefficient RT 10000000000 Large orebody
394.25
400 394.25
3.9425E-08
0.25
Drill 100% Small orebody
34.25
-5.5 24.25 40 34.25
2.425E-09 3.425E-09
0.7
Barren
0.5 -5.75
Target defined 0 -5.75
1 Risk-neutral project -5.75E-10
0 24.25 owners will prefer to 0.05
2.425E-09 fund the drilling and Large orebody
retain 100% equity in 199.75
the project 200 199.75
1.9975E-08
0.25
50% JV Small orebody
Detailed Geophysics 19.75
0 14.75000012 20 19.75
-0.25 12.00 1.475E-09 1.975E-09
1.2E-09 0.7
Barren
-0.25
0 -0.25
-2.5E-11
1 Carry out 0.5
12.00 geophysics and No target
1.2E-09 drilling in house -0.25
0 -0.25
-2.5E-11

Relinquish
0
0 0
0

FIG 12.7 - Example of exploration decision tree to determine whether to farm out at drilling stage.

EXAMPLE OF EXPLORATION DECISION TREE TO DETERMINE WHETHER TO FARM OUT AT DRILLING STAGE
A decision based on the certainty equivalent value Cx would be to farm the project out
0.05
Risk tolerance coefficient RT 100 Large orebody
394.25
400 394.25
0.981
0.25
Drill 100% Small orebody
34.25
-5.5 8.35 40 34.25
0.080 0.290
0.7
Barren
0.5 -5.75
Target defined 0 -5.75
2 A JV is preferred by -0.059
0 9.02 the risk-averse 0.05
0.086 project owners Large orebody
199.75
200 199.75
0.864
0.25
50% JV Small orebody
Detailed Geophysics 19.75
0 9.02 20 19.75
-0.25 4.28 0.086 0.179
0.042 0.7
Barren
-0.25
0 -0.25
-0.003
1 Carry out 0.5
4.28 geophysics in No target
0.042 house and -0.25
drilling under JV 0 -0.25
-0.003

Relinquish
0
0 0
0

FIG 12.8 - Certainty equivalents corresponding to the expected value tree of Figure 12.7.

Australian Mineral Economics 135

CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

owners would prefer to farm out 50 per cent equity in the project,
now worth a Cx of $9.02 million in exchange for the necessary
drilling funds, as the option of funding 100 per cent of the
drilling expenditure is now worth a lower Cx of $8.35 million.
Now consider (Figure 12.9) from the point of view of a party
potentially interested in farming into the project. The company’s
initial reconnaissance will have resolved some risk. Not only is
the expected value of $14.75 million desirable (see Figure 12.7),
but also its corresponding certainty equivalent (Cx) of $3.77 (see
Figure 12.9) million is also attractive.
In constructing a decision tree it makes sense to estimate the
duration of various activities and to place them in chronological
order in the correct intervals of time. It is also important to
specify in which dollar terms, ie whether nominal or real, are the
various inflows and outflows expressed.
The next logical step in using a decision tree as a project
evaluation tool, would be to apply an appropriate discount rate to
obtain the expected present value of the project. This process,
however is froth with complexity for mainly two reasons:
• firstly, as various actions resolve project uncertainty, in theory
the risk-and-time adjusted discount rate should decrease as
progression is made from left to right in tune with the
decreasing risk; and
consequence the relevant ‘risk-adjusted’ cash flows need only be
discounted to present value to account for the ‘time-value of
money’ but not for risk. In this light the appropriate discount rate
is the risk-free rate of interest.
Constructing a decision tree is not difficult. The challenge
rests with estimating the probability distributions of various
events.
Estimates of probabilities are generally subjective, ie based on
experience and informed advice.
An alternative way of estimating the order of magnitude of
relevant probabilities is to use frequency distributions derived
either from statistically significant experimental trials or more
often, from statistical analysis of historical time series.
Lord, Etheridge and Uttley (2003) have applied this latter
approach on Placer Dome’s relatively mature gold exploration
districts in the Laverton area of the Eastern Goldfield of Western
Australia. The material in Table 12.1, reproduced from their
paper, shows how, by spending $54.6 million over 13 years,
Placer generated 290 projects. They conducted systematic
drilling on 26 of these, discovered over ten million ounces of
gold and established 12 mines.
Thus in the Laverton district the average chance of discovering
833 333 ounces of gold would have been of the order of:

• secondly, different branches of a decision tree are characterised
by different levels of risk and should, in theory, be discounted at
different rates.
It must be kept in mind that the certainty equivalent values in a
decision tree, by definition, have already been ‘discounted’ by
the risk factor inherent in the utility function of the firm. As a
• 12/156 = 7.7 per cent, given a prospect has been defined; and
• 12/26 = 46.2 per cent, given that initial exploration has been
encouraging enough to justify systematic drill testing.
The tree of Figure 12.10 shows that, if one were to assume that
the ten million ounces target had a net value of $1 billion, ie
using current prices and a total cost of extraction and processing

CERTAINTY EQUIVALENT POINT OF VIEW OF PARTY FARMING IN

0.05
Risk tolerance coefficient RT 100 Event 3
194.5
All $ million 200 194.5
0.857
0.25
Enter 50% JV Event 4
14.5
-5.5 3.77 20 14.5
0.037 0.135
0.7
A risk-averse investor Event 5
1 would consider -5.5
3.77 entering into a 50% JV 0 -5.5
0.037 attractive -0.056541

Reject project
0
0 0
0

FIG 12.9 - The certainty equivalent point of view of the farming-in party.

TABLE 12.1
Historical exploration by Placer Dome in Laverton district (modified after Lord, Etheridge and Uttley, 2003).
Exploration stage Number of prospects Expenditure (A$ M) Average cost/prospect Probability of advancing
1987-99 (A$ M) from previous stage
Project generation 290 2.7 0.01
Prospect definition 156 11.4 0.07 53.79%
Systematic drill testing 26 6 0.23 16.67%
Resource delineation 15 6.9 0.46 57.69%
Feasibility 13 27.6 2.1 86.67%
Mine 12 92.31%

136 Australian Mineral Economics

 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

of A$ 450 per ounce, then, neglecting tax effects, the expected

-54.6
945.4

-20.1

-14.1

-2.7
-27

0
undiscounted value of this exploration campaign would be a
mere $30 million. This value could well turn negative if certainty
equivalents and an appropriate discount rate are applied. This
945.4

-54.6
would lend credence to the contention of Etheridge and Uttley
Uneconomic projects

(2003) that, in recent times, exploration has not created

12 Commercial mines

competitive value for mining companies.

92.31%

7.69%

0
1000.0

The tree also corroborates their view, (on the basis of the
observed frequency distributions that show that 58 per cent of
drilling targets led to resources delineation and that 87 per cent
of these justified feasibility studies resulting in 12 mines), that
868.5

-27

the maximum value is added at the time of the first economically

significant intersection of mineralisation and subsequent
Devepol mines

systematic drilling testing of 26 soundly selected targets, the

-27.6

0
Abandon

expected value of which is A$ 423.7 million.

On this basis they also suggest that ‘drilling investment funds’
that provide major contributors with a right to buy back 50 to 60 per
1

1
Do not justify feasibility
868.5

-27

cent project equity in case of large discoveries, could be an

attractive investment vehicle to major companies for the purpose of
13 Justify feasibility

specifically drill-testing robust targets. It is possible to justify this

86.67%

13.33%
0

FIG 12.10 - Assessing Placer Dome’s historical gold exploration in the Laverton area. view as long as there continues to be a reasonable supply of such
targets from the activities of juniors and middle-size exploration
companies, which majors, equity investors or both might adequately
fund. A progressive disappearance of readily available targets will
Resources delineation

-20.1
749.1

presumably have the effect of increasing the cost of grass-roots

exploration and the value of defined drilling target.
-6.9

0
Abandon

MODERN ASSET PRICING (MAP) USING

COMMODITY FORWARD PRICES
1

1
749.1

-20.1

No-arbitrage and replicating portfolios principles

15 Mineralisation

A fundamental assumption underlying option valuations is that

57.69%

42.31%
0

0
Barren

financial markets are frictionless and display relatively high

levels of efficiency, ie relevant information is rapidly
disseminated and incorporated in the price of assets. Under these
circumstances (Salahor, 1998), assets with similar risk
423.7

-14.1
Systematic drilling

characteristics and producing the same cash flows at the

same times in the future should have the same price.
-6

0
After 13 years and $54.6 M in exploration expenditure Placer discovered 12 deposits containing in excess of 10 million ounces of gold worth A$ 1 billion

Abandon

If this value consistency principle did not apply, then

arbitrageurs would have an opportunity to make a risk-free profit
by buying undervalued assets and selling overvalued ones.
1

Arbitrage opportunities are infrequent and short-lived. This is

423.7

-14.1
26 Drill target identified

known as the no-arbitrage or one-price principle. Thus cash

No drill target

flows can be viewed (Bradley, 1998) as commodities, with

16.67%

83.33%
0

timing and risk as criteria of value.

Furthermore, according to the value additivity principle, the
components of a cash flow model (eg revenue and costs) can be
PLACER'S HISTORICAL GOLD EXPLORATION ACTIVITY IN THE LAVERTON AREA

separately evaluated, appropriately discounted and recombined.

-2.7
58.9
OF THE EASTERN GOLDFIELDS OF WESTERN AUSTRALIA (After Lord, 2003 )

Prospect definition

In this light, as discussed below, the present value of holding a

claim on a future cash flow, irrespective of the underlying assets
0
-11.4

Abandon

from which it is derived, can be simulated by a replicating

portfolio of different investments, as long as they provide the
same present value.
at current prices assuming a A$450/oz. total cost of extraction and processing

Under no-arbitrage conditions Samis (2002) visualises a

No prospects identified
58.9

-2.7
156 Prospects identified

mining project producing a highly price-volatile commodity as a

set of contingent claims on future cash flows providing the same
53.79%

46.21%
0

value as a replicating portfolio2 composed of:

2. In theory, the holder of proven mineral reserves in the ground,

No grassroot exploration
30.4

supported by a strong bankable feasibility study, would not need to

290 Projects generated

develop a physical mine to achieve the same cash flows results. For
commodities such as gold, the prices of which are dominated by
-2.7

contango (ie with futures prices higher than the corresponding spot
prices) a ‘virtual mine’, made up of a series of rolling forward sales
matching the production schedule of the mining plan in the
feasibility study, would have the same cash flow effect. The main
1
30.4

reason why ‘virtual mines’ do not exist is because the fiscal regime,
while tolerating rolling over of forward sales as a legitimate hedging
in tune with future physical production, acts as a disincentive to pure
speculation.

Australian Mineral Economics 137

CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
• A series of forward contracts, with quantities and delivery
dates matching the mineral production schedule of the mine.
After all, the present value of a unit of production at various
times in the future is exactly replicated by the corresponding
forward prices, which incorporate discounting for risk.
• Issuing a series of bonds with principal repayments of a
magnitude and maturity matching the estimated annual cash
outflows related to the emerging capital and operating costs
of the project. This approximation is broadly warranted
because capital and operating costs can be estimated with a
higher degree of confidence and can, to some degree, be kept
on budget by sound technical and financial management.
Commodities forward prices as certainty
equivalents
Commodities forward sales are a form of ‘certainty
equivalents’ because the binding nature of forward contracts
means that a seller must deliver and a buyer accept delivery of
the mineral commodity units contracted for at a price and on a
delivery date firmly agreed in the present. In other words the
seller will receive the agreed price in cash and with certainty at
the time of delivery. Forward prices take into account and
compensate for the potentially high volatility of the spot
commodity price in the future and are adjusted for convenience
yields (ie any possible leasing/dividend cash inflow net of related
storage, insurance and financing costs of holding the commodity
that accrue to the holder of the physical stock).
As a consequence, one can build models of mining projects
that separate the revenue function from the cost function and by
using forward prices as the relevant price input determine the
project revenue cash flows with certainty. As the use of secure
forward contract sales removes the main component of risk (ie
the price risk) from the estimate, it would then be inappropriate
to use a risk-and-time-adjusted discount rate to obtain the present
value of future revenue cash flows. If such an approach, which
obviates the need for risk discounting, is adopted, then the only
discount to be applied is the risk-free rate to compensate only
for the time-value of future cash flows.
Sophisticated project modelling and evaluation methodologies,
such as:
• modern asset pricing (MAP), and
• real options valuation (ROV),
discussed below, instead of using a single time and risk-adjusted
discount rate entail (see Figure 12.11) a two-step process of:
• determining certainty equivalents for the undiscounted
cash flows through various forms of risk neutralisation;
and then
FIG 12.11 - Differences between discounting in DCF analysis and
in real options valuations (after Dias, 2002).
138
• discounting them for their timing using the risk-free
rate of interest.
The MAP modelling methodology, which is an elementary
form of real option valuation (Salahor, 1998, p 15; Laughton,
1998), is easy to apply and gives good, generally conservative,
estimates of the value of a project under the assumption that the
bulk of its risk is linked to the volatility of the price of the
commodity produced. As discussed later, there are other forms of
real option valuations that ‘neutralise’ the volatility not just of
the revenue but of the overall cash flows of a project
encompassing all other sources of risk besides price risk.
For some commodities forward prices quotes are readily
available on the London Metal Exchange (LME) for deliveries
up to 27 months in the future. This makes MAP evaluation of
short-lived mining operations very accurate and convenient as
the following example will illustrate.
In Table 12.2 we will calculate the MAP/NPV of a nickel mine,
with 27 months (nine quarters) remaining productive life by
‘neutralising’ the nickel price risk using forward prices for various
delivery dates as quoted on the LME. On 30 August, 2005, when
the spot price for nickel was US$ 14 950 per tonne, the three, 15
and 27 months deliveries were quoted at US$ 14 850, US$ 13 700
and US$ 12 400 per tonne respectively, as shown in Figure 12.12.
At a conversion factor of 1 kg equal 2.204623 pounds, these
forward quotes convert to US$ 6.78, US$ 6.21 and US$ 5.62/lb
respectively.
FORWARD Ni PRICE CURVES
30 August 2005 Estimates
$18,000.00
$16,000.00
Ni Price ($US/t)
$14,000.00
$12,000.00
$10,000.00
$8,000.00
$6,000.00
0 2 4 6 8
Time (years)
Expected spot price ($/unit) Forward price ($/unit)
Lower 10% confidence Upper 10% confidence
Average LME Forward Quote Calibration
FIG 12.12 - Projected spot and forward nickel price curves as of
30 August 2005.
Lets further assume that the mine produces two million pounds
of payable nickel per quarter at a cash cost of US(Year 0)$3.00/lb
under a turn-key mining and processing contract with unit costs
rising in line with the inflation rate estimated at three per cent
per annum. The company has committed its full production
forward with sales in quarters 1, 5 and 9. Undepreciated capital
assets with a fiscal written down value of US$ 10 million can be
depreciated on a straight line over the nine quarters. Nickel
royalties are 2.5 per cent and corporate tax is 30 per cent. The
nominal risk-free rate of interest is 5.68 per cent per annum.
As the model is built on quarterly periods, care must be
exercised to make sure that relevant inputs are also on a
quarterly basis. So the quarterly rate of inflation becomes
[(1 + 3 per cent)0.25] - 1 = 0.74 per cent and the nominal
quarterly risk-free rate of interest 1.39 per cent.
From Table 12.3 it can be seen that, under the assumptions, the
MAP/NPV of this project, subject to discounting by the risk-free
rate because of elimination of the price risk through the use of
forwards prices and of operational risk through the turn-key
mining contract, is $24.37 million.
Australian Mineral Economics
 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

TABLE 12.2
Comparison between the DCF/NPV and MAP/NPV of an operating nickel mine.
MAP MODEL – Time (quarters) 1 2 3 4 5 6 7 8 9
Sales (lb*million) 2.00 8.00 8.00
Forward price (US$/lb) 6.78 6.21 5.62
Total revenue (US$ million) 13.56 49.71 45.00
Less royalty at 2.5% 0.34 1.24 1.12
Unit cost of production (US$/lb) 3.02 3.11 3.21
Total cost of production (US$ million) 6.04 24.90 25.65
Depreciation 1.11 4.44 4.44
Profit after 30% tax 4.25 13.39 9.64
Net cash flow 5.36 17.83 14.09
Risk-free discount factor 0.9863 0.9333 0.8832
MAP discounted CFs (US$ million) 5.29 16.64 12.44
MAP/NPV (US$ million) 24.37
DCF MODEL – Time (quarters) 1 2 3 4 5 6 7 8 9
Sales (lb*million) 2.00 8.00 8.00
Expected spot price (US$/lb) 6.75 6.54 6.25
Total revenue (US$ million) 13.51 52.35 50.00
Less royalty at 2.5% 0.34 1.31 1.25
Unit cost of production (US$/lb) 3.02 3.11 3.21
Total cost of production (US$ million) 6.04 24.90 25.65
Depreciation 1.11 4.44 4.44
Profit after 30% tax 4.21 15.19 13.06
Net cash flow 5.32 19.63 17.50
Risk-and-time-adjusted discount rate per quarter (%) 3.57%
Risk-and-time-adjusted discount (RTAD) pa (%) 15.07% Risk-premium 9.39%
Risk-and-time-adjusted discount factor 0.9655 0.8390 0.7291
Discounted CFs 5.14 16.47 12.76
DCF/NPV (US$ million) 24.37

TABLE 12.3 of a risk-free interest component of 5.68 per cent and of a

risk-premium of 9.39 per cent. If a further assumuption is made
Calculation of the real option value of Sally Malay using the
Black and Scholes formula. that the market portfolio premium inherent in it were the
medium-term average of 6.5 per cent, then it is possible to
C = Value of real option (ROV) (A$ million) 21.33 conclude that the company holding this project has a β of around
d1 0.8578 1.4; not an unlikely result for a small mining company.
d2 -0.1040 Of course in practice most companies do not attempt to carry
out MAP evaluation of their projects to derive an appropriate
S = Spot price = PV of net after-tax operating cash flows 43.94 discount rate (even though it would be wise to do so), but use
(A$ M)
discount rates determined by directorial policy which may or
X = Exercise price = PV of capital investments (A$ M) 53 may not relate to the firm’s WACC. In general if a firm selects a
t = Time to expiry (years) 11 discount rate lower than that implicit in a MAP valuation, it
σ = Cash flow volatility 0.29 would discount less its operating and maintenance costs and tend
to favour, equal being the revenue inflows, more capital intensive
δ = Convenience yield 0
solutions and vice versa.
Risk-free interest percentage 0.05
For operations with longer mine lives, analysts must forecast
ENPV = Enhanced NPV = NPV + ROV (A$ million) 12.27 forward commodity prices beyond the longest available delivery
quotation available on the LME (ie 27 months) using stochastic
The corresponding conventional DCF model can now be (probabilistic) models of their market behaviour. Under normal
constructed by estimating (as discussed below) and inputting the market conditions, prices generally distribute log-normally and
expected spot prices for quarters 1, 5 and 9 (ie US$ 6.75, US$ 6.54 follow a geometric Brownian motion (GBM) around a mean
and US$ 6.25/lb respectively) instead of the LME forward prices trend or drift. GBM means that in any interval of time, prices
quotes. An approximate nominal rate of risk-and-time adjusted will never be negative and can either go up or down
discount can initially be input and then by iteration (using the randomly as a function of their volatility.
Excel goalseek function) the risk and time adjusted discount rate Furthermore, following any unusual price-shock, the prices of
can be determined, which gives a DCF/NPV of $34.37 million, ie most mineral commodities (see the nickel example in Figure
the same as that obtained in the fully hedged MAP model. This 12.12) gradually revert to their mean trend or drift because
nominal risk-and-time adjusted discount rate is, in this example, market forces react by bringing new supplies into production in
15.07 per cent. Recalling the capital asset pricing model (CAPM) the case of significant price increases, or reduce supplies for falls
discussed in Chapter 9, it is clear that this discount rate is made up in price.

Australian Mineral Economics 139

CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
Figure 12.12 was constructed using the standard GBM for
continuous spot price changes (dS) including reversion to the
mean and error factors, ie:
dS = [α * +0.5 σ 2 − γ ln( S / S*)]S dt + σ S dz
where:
α* is short-term growth rate of the price median
S is current spot price
S* is current long-term price median
σ is short-term price volatility
γ is ln(2)/half-life = reversion factor
z is standard random variable
If a very high half-life value is input in the γ formula, then the
value of γ tends to zero and the GBM algorithm can be used to
forecast the behaviour of the price of non-reverting commodities
such as gold. The gold price non-reverting behaviour, which is
more akin to that of financial securities rather than that of other
mineral commodities, represents a notable exception, which can
be explained by the quasi-monetary role played by gold in the
financial system.
More details about this price forecast model can be found in
articles by Baker, Mayfield and Parsons (1998), Salahor (1998),
and Samis (2002), who deal with its various mathematical
components and derivation.
FROM STATIC DCF/NPV TO DYNAMIC REAL
OPTION VALUATIONS (ROV)
A different logic
For resources projects:
• with healthy NPVs, low volatility in their cash flows; and
• where management has limited flexibility, ie the opportunity
to change their course of action during operations in light of
emerging circumstances,
DCF analysis will continue to provide the dominant investment
decision-making criteria.
Interestingly, lack of managerial flexibility in the presence of
high volatility is indeed what differentiates a bet (ie put your
money down and wait for the outcome) (Copeland and Keenan,
1998), from an investment in a project capable of offering a
range of strategic options.
However, many projects may feature low or even negative
NPV because analysts have discounted them at excessively high
rates to compensate for high volatility in their cash flows. Much
of this CF volatility typically comes from high volatility in the
price of the commodities they produce (price risk) and of other
uncertain inputs.
Yet such projects can be very valuable if their inherent
characteristics or their design provides management flexibility
to take advantage of up-swings (eg rising prices) and avoid or
minimise the effect of downswings. If for a period of time the
decision-makers have the right but not the obligation to
proceed with the initial or successive investment phases in a
project only if conditions prove favourable, the project is said to
offer real option value (ROV) and the project volatility can be
the source of significant value.
As the words imply real options (RO) have to do with real
assets such as exploration and mining projects, rather than the
financial assets, which underpin traded derivatives.
Mineral and petroleum exploration, research and development
and, pilot studies, for instance, have the characteristics of real
140
options, in that they create opportunities but no obligations to
invest. Yet many of these projects continue to be under-funded
and often unwisely rejected. Even worse, projects involving new,
untested technology may sometimes be commissioned without
adequate piloting in the hope of shortening their lead times and
lowering their overall capital cost. This frequently leads to
disastrous results.
This type of error occurs because investors do not fully
recognise and value management flexibility to keep their future
options open to progressively learn and adjust their actions as a
project unfolds, depending on emerging circumstances and
information dispelling uncertainty.
Consider the following example of this fallacious logic,
adapted from Copeland and Keenan (1998). Assume an
opportunity to invest in a $100 million project that has:
• a 50 per cent chance of success of realising a present value of
$150 million in future net after-tax operating cash flows; and
• a 50 per cent chance of failing, such that only $10 million
would be salvaged.
As the expected monetary value (EMV) is negative:
EMV = 50% * ($150 M - $100 M) + 50% * ($10 M - $100 M)
= -$20 M
DCF-logic would lead to rejecting this project.
Now assume that the company can build and test a pilot plant
for $10 million. If the pilot plant were effective in resolving an
adequate level of project uncertainty then the EMV of the project
would become positive. At the limit, if the pilot plant were to
dispel all the uncertainty the EMV would become:
EMV = 50% * ($150 M - $110 M) + 50% * ($0 - $10 M)
= $15 M
Real-option logic would lead to the decision of investing in
the pilot plant. If it is successful, then the company should
invest in the project. If not, it can abandon the investment at a
relatively low cost and with no regret of having missed out on a
potentially lucrative investment opportunity.
DCF/NPV analysis is deterministic and static. It assumes that
an investment is irreversible and it compares investing ‘now or
never’ (Dixit and Pindyck, 1995). In DCF models there are no
inherent or planned contingencies to delay development, expand
or contract production rates. In reality, and irrespective of
whether the decision to invest was taken on the basis of
DCF/NPV criteria, projects evolve according to unfolding
circumstances that often require unexpected and costly changes.
At least this is the case unless possible future eventualities were
already anticipated and incorporated in the project plan to soften
the effect of uncontrollable chance events.
Types of real options in mining projects
Most real options in the context of the mining industry entail the
managerial flexibility to undertake actions such as:
1. delay mine development and learn;
2. embark in a pilot project and learn;
3. commence development and production on a staged basis,
learn and, if warranted alter the rate of production, by
exploiting grade-tonnages trade-offs, ie:
a. expand to include lower grade resources into reserves, or
b. contract by high-grading the reserves;
4. suspend or recommence production temporarily; or
5. abandon a project altogether.
Australian Mineral Economics
 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
The first three (up to 3a) are call options; while 3b and 5 by
contrast are more akin to put options, conferring the right but not
the obligation to ‘sell’ the project to generate savings or avoid
future potential losses (S), for a predetermined price (X) (eg care
and maintenance, abandonment, severance and rehabilitation
costs) at or before a predetermined time (t). The fourth option,
known as a switching option, is a combination of call if
recommencing production and put if suspending it.
Depending on the nature of the project it is possible to
distinguish between:
• Single options, when there is only one possible decision or
the alternative is delaying investment at each node.
• Multiple and chooser options (Mun, 2002), when at any
node there is more than one possible decision as opposed to
delaying the investment. In the case of the chooser option the
alternative decisions are mutually exclusive.
• Sequential/compound options, when there is a series of
decision nodes in chronological order (eg exploration project
stages), where each successive decision may or may not be
conditional or compound on a previous one.
It is therefore possible to view most projects as a series of real
options to defer and learn, commence, expand, contract or
suspend production or finally abandon the project, the value of
which is not captured by the traditional static NPV. This can be
modelled as a tree-like structure of sequential possible future
scenarios with probability nodes representing ‘states of nature’,
not under management control. The branches that emanate from
each node, in turn lead to distinct groups of possible future
scenarios. Each branch represents a possible action, which
managers may decide to undertake ‘with the wisdom of
hindsight’ to optimise the returns from the project, depending on
emerging circumstances and the arrival of new information over
time resolving uncertainty at each successive node.
By waiting for new information before selecting a course of
action, managers can learn and make dynamic decisions on the
basis of the ‘bad and good news principle’, ie participate in
positive outcomes and avoid negative ones.
The market has been effective at setting real
option values – considering the case of Sally
Malay
If we could assume that new information is quickly disseminated
in the market place and incorporated in prices (ie if opportunities
for arbitrage were few and short-lived), an objectively assessed
NPV of a project should also closely match its fair market value
(Lawrence, 2001). Yet examination of actual mining project
transactions often shows significant differences (generally a
premium) between their stock market and their fundamental
(DCF/NPV) valuations.
Lawrence (2001) attributes this difference to the widespread
international use of reporting guidelines that encourage
valuations primarily based on proven and probable reserves (as
categorised in the Australasian Joint Ore Reserves Committee’s
JORC code, 2004). This approach, he argues, disregards the
potential contribution to revenue from more uncertain and lower
grade resources categories and tends to underestimate the
potential project value in fundamental DCF calculations.
Irrespective of the categories of resources used, if one follows
strict JORC logic to the limit, any company holding tenements
over a marginal deposit with a negative NPV at current
commodity prices would be justified in relinquishing them. As a
consequence, the value of the company shares should fall to zero
in the absence of other significant assets in its portfolio.
The stock market, however, has traditionally placed a value on
option creation, particularly by non-dividend-paying mineral and
petroleum exploration companies. Until recently quantitative
methodologies to measure this value have been lacking.
Australian Mineral Economics
To illustrate the point we will use the example of Sally Malay
Mining Ltd, which in 2001 was a prospective nickel mining
company holding sub-economic nickel resources in the Kimberley
region of Western Australia. Soon after its Initial Public Offering
(IPO) in September 2001, when the price of nickel was around
US$ 5000/tonne, the company had a market capitalisation of
around A$ 12.2 million. This value arose in part because:
• The project was based on a commodity (ie nickel) with high
price volatility. (London Metal Exchange price data show the
volatility of the nickel price to be between 20 and 25
per cent).
• Additionally, there was still, under prevailing mining
tenements rules, a reasonable length of time before the
company had to make a decision to develop the mine or risk
that the relevant mining leases would not be extended by the
government for a further 21-years term. During this period
the company was in a position to delay the investment in
mine development at the relatively low cost of simply
keeping the mining tenements in valid legal standing.
Interested investors also hoped that during this time of
potentially rising nickel prices, further drilling might lead to
extensions to existing reserves and conversion of previously
uneconomic indicated resources into additional ore reserves.
If the nickel price current in September 2001 (ie US$ 5000/t)
were to be input in a deterministic DCF model of this mining
deposit, containing 3.4 million tonnes of diluted mining reserves at
a grade of 2.32 per cent nickel equivalent, its resulting net present
value would have been very low or even negative. For instance,
assuming capital costs of A$ 53 million (including A$ 7 million in
working capital), cash operating and maintenance and concentrate
transport costs of A$ 3.00 per pound of sellable nickel in
concentrate, average recoveries, smelter returns and exchange
rates, a modest salvage value, etc would have resulted in a
negative NPV of the order of -$9.0 million using a real discount of
six per cent and allowing for inflation averaging three per cent.
This, however, would have been a rigid, irreversible view of
the project future and its value, equivalent to being committed to
start and operate the project for five years through possible good
and bad times, irrespective of what happened to the price of
nickel. It implied no merit in holding the project and no capacity,
once the decision to develop was taken, to avoid or at least
mitigate the likely adverse impact of potential future price falls.
However, there was a widespread perception that an economic
recovery was just around the corner. The price of nickel was at
historically low levels and it was likely to rise strongly. When
these expectations were incorporated into discounted cash flow
models, they produced healthier net present values, justifying the
decision by investors to purchase Sally Malay Mining’s Ltd
shares and its market capitalisation of A$ 12.2 million. The idea
of relinquishing the tenements would have been preposterous
even at the end of 1999 when nickel prices stood at a mere
US$ 3600 per tonne. Indeed the previous owner, Helix Resources
NL, sold it to the current owners around that time for a
significant cash consideration.
The static NPV completely disregarded the fact that the
company had the flexibility to delay development until the
nickel price conditions indicated that the project would add
rather than consume value. There are in theory no negative NPV
scenarios when one has the option to delay investment because,
at worst, the value of the project is zero (or close to it if there are
costs in keeping the option open as for instance retention leases
fees). This is a dynamic view of the project future and the basis
to value its inherent managerial flexibility to only develop if high
nickel prices eventuate. As will become clearer later, this value,
which is not captured by conventional DCF/NPV, can be very
significant.
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Prior to dramatic increases in nickel prices in late 2003, the
situation at Sally Malay had all the characteristics of an
out-of-the-money American call option, conferring the right but
not the obligation at the discretion of its owners:
• to defer or proceed with a A$ 53 million capital investment
in development of the project and sustaining capital, which is
analogous to the exercise (or strike) price (X) of this option;
• to develop at any time on or before the expiry date of the
mining leases in 11 years, which is analogous to the term (t)
of the option; and
• to derive a net benefit equal to the present value of all future
net after-tax operating cash flows amounting to A$ 43.94
million, which is analogous to the spot price of the underlying
asset (S).
Naturally development can proceed only if S-X is positive;
otherwise it is preferable to defer it. This means that the option
value of the project can only be positive ie the maximum
between S-X and zero.
As the price of nickel increased to around US$ 7000 per tonne
by the end of 2002 on its climb to US$ 16 000 per tonne by the
end of 2003, the option got well ‘in the money’ and it warranted
being exercised. That is, it became profitable to develop the Sally
Malay mine.
The NPV of the project had improved from marginal at 2001
prices to between A$ 51 to A$ 58 million by the middle of 2003
using realistic nickel prices of US$ 6500 and US$ 7000 per
tonne, at a nominal discount rate of 7.5 per cent.
The company’s market capitalisation, of around A$ 115
million in March, 2004, reflected:
• the project sensitivity to continued increases in nickel prices
late in 2003;
• the positive market sentiment about the exploration potential
in the areas surrounding the mine at these price levels; and
• tempered by the hedging effect of forward sales.
It also reflected, the realisation that nickel prices had stabilised
and an expectation that they would start to progressively fall,
reverting to their long-term mean, as indicated by the London
Metal Exchange forward contracts and futures quotes.
Estimating the real option value of the Sally
Malay project in September 2001
The only way to capture investors’ expectations at the time of
Sally Malay’s initial public offering in 2001, which justified a
$12.2 million capitalisation for this company, well in excess of
its deterministic NPV of -$9.07 million, would have been by
estimating its real option value (ROV).
Determination of this ROV was easy in this case because of
the call nature of the real option inherent in this project, which
lent itself to be handled effectively using a close-form equation,
namely the Black and Scholes (B-S) formula (Peirson, Brown,
Easton and Howard, 2002, p 633):
Price of call = C = SN(d1) – X e-rT N(d2)
where:
d1 = (ln(S/X) + (r – δ + σ2/2) T) / (σT0.5)
d2 = d1 - (σT0.5)
S is spot price
X is exercise price
σ is standard deviation of the logarithm of stock returns
percentage expressed as decimals
142
T is time to exercise in years
r is risk-free rate of interest annual percentage expressed as
decimal
N(d) is cumulative standard normal distribution density function
with upper integral limit d
δ is convenience yield (dividend) in percentage per annum
expressed as decimal
In addition to the assumptions already discussed, the volatility
of the cash flows of this project was estimated to be 29 per cent,
much of which was represented by the volatility of nickel prices
and the rest by a variety of other uncertain project inputs. Another
necessary input was the risk-free rate of interest (RF), which was
estimated at five per cent, ie at a premium of 0.25 per cent above
the 4.75 per cent RBA cash rate prevailing at the time.
On this basis, the real option value (ROV) of this project was
assessed at $21.33 million, as shown in Table 12.3.
The net present asset value (NPAV) or expanded net present
value (ENPV) (Mun, 2002, p 168) of the project/company,
assuming no other significant assets in its portfolio at that time, is
then the sum of its NPV and ROV, ie:
ENPV = NPV + ROV = -$9.06 million + $21.33 million =
$12.27 million
This figure is remarkably close to the company’s market
capitalisation at the time, ie around A$ 12.2 million, but very
sensitive to the estimates of the various inputs particularly the
difficult-to-compute volatility of project net after-tax operating
cash flows.
In addition, it must be borne in mind that the B-S formula was
specifically devised to value financial derivatives and not real
options and is based on a range of assumptions some of which
may be too restrictive and unrealistic in the context of real options.
For instance the lack of continuous direct frictionless trading
and market valuations of mining project underlying a real option,
falls a lot shorter than its financial securities counterparts, where a
lot of the necessary metrics can be easily derived from market
records. Mining projects, by contrast are, infrequently traded and
their underlying value for the purpose of ROV modelling can only
be assumed, according to Copeland and Antikarov (2003, p 94), to
be their DCF/NPV at an appropriate risk-and-time adjusted rate of
discount. This assumption is known as the ‘marketed asset
disclaimer’ or MAD.
The volatility of returns from a mining project cannot, as it is
the case with financial securities, be simply generated from the
ASX statistics and may require complex forecasts and Monte
Carlo simulations.
Furthermore the B-S formula also implies that option values are
always positive, thus not helping where there are abandonment
costs in mining projects. The assumption of constant volatility and
risk-free interest, exercise at expiry, etc inherent in the Black and
Scholes formula also make determination of real option values
using this type of closed-form equation unreliable other than in the
most simplified option models such as in the case of the Sally
Malay delaying option, where it provides a reasonable order of
magnitude ROV.
In many cases where real options have more complex multiple,
sequential and compound structures use of the B-S formula with
its limitations and constraints may become infeasible, then more
complex but more versatile methods, such as the binomial
lattice method, will need to be used instead.
USING BINOMIAL LATTICES IN VALUING REAL
OPTIONS IN PRACTICE
While price volatility is the predominant source of volatility in
the cash flows of many mining projects, it is not the only source
of uncertainty. A significant degree of uncertainty may be
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 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
attributable to other revenue input components, to which the
performance of the project is highly sensitive. These include
uncertainty surrounding the estimates of:
• grade and tonnages of ore reserves;
• metallurgical recovery (taking into account its correlation
with grades); and
• exchange rates between the Australian and United States
dollars (making allowance for a degree of correlation
between US$-denominated prices and the Australian dollar
given its so-called ‘commodities currency’ characteristics;
and so on.
While it is mathematically possible through complex
stochastic calculus and partial differential equations to build
specific project models that take into account and combine the
volatility of the various project inputs, as their number increases
the construction of a realistic mathematical model for application
in MAP or to generate a closed-form equation becomes very hard
to handle in practice.
A more friendly way to construct a real option model of a
project is by using the volatility of its future net after-tax cash
flows, rather than the individual volatilities of various inputs.
After all, the volatility of the project cash flows is a complexly
‘weighted’ function of the volatility of all the project inputs.
Such an approach provides more accurate results, as long as
one is able to estimate the cash flow volatility (σ) with some
degree of confidence. Methods to estimate volatility, as described
in Copeland and Antikarov (2003, pp 244-269) and Mun (2002,
pp 197- 202), can be problematic at times and probably represent
the greatest challenges in carrying out real option valuations.
They include:
• the logarithmic present value approach;
• the management assumption approach; and
• the market proxy approach, where the project under
consideration is similar to those of a number of companies
traded on the stock exchange.
The logarithmic present value method entails:
1. determining the function X = ln[(PV at t=1 of Σ t=1 to n net
operating CFs)/ PV at t=0 of Σ t=0 to n net operating CFs)]; then
2. running a Monte Carlo simulation on the numerator only
to define the volatility (σ) of X, which in fact is the
volatility of the project cash flows.
All these methods require the use of sophisticated risk-analysis
simulation software.
The alternative of carrying out dynamic optimisation
techniques based on simulation, while appropriate for some
specific applications, has generally proved to be somewhat
impractical when modelling mining projects.
By contrast, once the cash flow volatility of a project has been
estimated, it becomes possible to make use not only of
established closed-form equations (of which the B-S formula is a
well-known example) but also of the more versatile and friendly
binomial lattice methods.
Ito’s Lemma states that a dependent variable (such as the
revenue cash flows of a project), which is a function of a
stochastic process (eg commodity prices) is itself a stochastic
process. As a consequence, the NPV of a project can also either
go up or down over an interval of time along a path determined
by its mean and volatility which in turn are a function of the
combined volatility of the price of the commodity produced and
of all other significant uncertain variables.
Mun (2002) describes several possible real option valuation
approaches based on the binomial lattice (and related trinomial
and multinomial) methods including:
Australian Mineral Economics
• the relatively friendly ‘risk-free probability’ method,
• the ‘state prices’ method, and
• the somewhat less friendly ‘replicating portfolio’ method.
Binary systems with two possible, mutually exclusive
outcomes of the type success or failure (or up or down) generally
adhere to the discrete binomial probability distribution, which
explains its importance in option analysis. In discrete binomial
systems:
• success means the price will rise in any unit of time by a
factor (1 + σ), where σ is the measure of volatility per unit of
time (T in years); while
• failure means that the price will fall by a factor of 1/(1 + σ).
If a smaller (at the limit infinitesimal) time interval is selected
(∆t = T/n, where T is the time to expiry and n is the number of
time subdivisions), the discrete binomial distribution lattice tends
to become finer-grained, continuous and exponential with:
up factor: Up = exp(σ*∆t 0.5); and
down factor: Down = 1/UF = exp(-σ*∆t 0.5).
Mun (2002) shows that these exponential formulae provide a
reasonable approximation of the corresponding discrete binomial
distribution even when the time intervals are reasonably coarse.
For this reason he recommends the binomial lattice as the most
practical way of modelling real options.
Of the three ways of neutralising risk, he also recommends the
‘risk-free probability (p)’ approach as the most practical and
versatile. Its formula is:
p = [exp((r-b)*∆t) – Down] / (Up – Down)
where r is the risk-free rate of interest, and b represents any
continuous dividend payout, if applicable, expressed as decimals.
An alternative to ‘risk-free probabilities’ is to use ‘state
prices’. A ‘state asset’ is a claim that pays a future cash flow of
$1 if a particular state of nature occurs, with no loss if the desired
state of nature does not eventuate. A ‘state price’ is the amount
an investor would be prepared to pay today for a state asset. It is
in effect the risk- and time-discounted value of $1 to be received
if the relevant state of nature eventuates, with no alternative loss.
Benninga (2000, pp 253-273) describes this method and its
relationship to a ‘replicating portfolio’ and the Black and Scholes
formula, in easily understandable terms.
Each of these methods seeks to ‘neutralise’ risk by analysing
and mathematically manipulating the individual risk characteristics
of each project/investment opportunity. Proof of the
risk-neutralisation capacity of these techniques is beyond the scope
of this chapter. Benninga (2000) provides a simple introduction to
the concept of replicating portfolio and state prices, while Copeland
and Antikarov (2003) discuss ‘risk-neutral’ probabilities. Mun
(2002) identifies a number of distinct steps in the process of
determining the ROV of a project. These are essentially:
1. constructing a static DCF base case model of the project;
2. carrying out a Monte Carlo simulation of its outputs (eg its
expected NPV and volatility of net, after-tax, operating
cash flows) to be used as inputs in the real option valuation;
3. identifying and modelling the real option(s);
4. applying an appropriate real option valuation method and
optimising choices/decisions; and
5. reporting and communicating the results effectively.
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VALUING AN EXPANSION OPTION WITH THE
BINOMIAL LATTICE METHOD USING THE
‘RISK-FREE PROBABILITY’
The binomial lattice with ‘risk-free probabilities’ is the simplest
and most versatile next step in overcoming complexity and
achieving greater realism. This will be illustrated by valuing an
expansion option.
Consider a gold custom mill with an annual capacity of one
million tonnes of ore and a static NPV of $60 million. Following
Mun (2002, p 198), the volatility of the logarithmic returns on its
future cash flows is estimated using a Monte Carlo simulation to
be 35 per cent.
The owners of the mill have been successful in attracting ore
to their facility and they envisage that within the next few years it
may be possible to significantly increase the current volumes of
ore treated. As a consequence they are seriously considering
expanding their capacity.
They have now become aware that a mine in the region is
approaching exhaustion and that its owners would be agreeable
to sell their mill with a 0.6 million tonnes annual capacity at any
time during the next five years for $40 million, and if necessary
letting the acquirer treat their remaining ore on a custom basis.
This represents a potential 60 per cent expansion, which would
increase the NPV by a factor of 1.6 minus the acquisition
(exercise) price of $40 million. The option is at present not ‘in
the money’ because, if exercised, the value of the expanded
enterprise would be 1.6 * $60 million minus $40 million ie
$56 million which is less than the NPV of not expanding the mill
currently worth $60 million.
Given the high volatility and long time to its expiry, this does
not mean that the option is worthless. To the contrary both the
buyer and the writer of the option need to determine how much
the option may be worth as a basis for negotiations.
This classical expansion option lends itself to being solved by
applying the ‘risk-free probability’ to the relevant binomial
lattice of the asset.
Firstly, one must calculate the:
• up factor Up = exp(σ*∆t 0.5) = 1.419;
• down factor Down = exp(-σ*∆t 0.5) = 0.705; and
• ‘risk-free probability’ p = [exp((r-b)*∆t) – Down] / (Up –
Down) = 0.515.
Then one must construct, as in Table 12.4, the binomial lattice
displaying the effect of various combinations of ups and downs
on the NPV of the underlying asset.

TABLE 12.4
Expansion option evaluated using a binomial lattice with the risk-free probability method.

Expansion option binomial lattice

Asset value ($) 60 Stepping-time (dt) 1
Implementation cost ($) 40 Up-step size (up) 1.419
Maturity (years) 5 Down-step size (down) 0.705
Risk-free rate (%) 7.00% Risk-neutral probability (p) 0.515
Dividend (%) 0.00% Continuous time discount factor 0.932394
Volatility (%) 35.00%
Lattice steps 5
Expansion factor 60.00%
Time 0 1 2 3 4 5
Possible outcomes
Certain u 2u 3u 4u 5u
d du d2u d3u d4u
2d 2du 2d2u 2d3u
3d 3du 3d2u
4d 4du
5d
Value of possible outcomes
60.0 85.1 120.8 171.5 243.3 345.3
42.3 60.0 85.1 120.8 171.5
29.8 42.3 60.0 85.1
21.0 29.8 42.3
14.8 21.0
10.4
Expanded NPV including option value
63.0 101.4 158.3 239.6 352.0 512.4 Expand
31.7 56.0 95.8 156.0 234.3 Expand
10.6 22.2 46.2 96.2 Expand
0.0 0.0 0.0 End
0.0 0.0 End
0.0 End

144 Australian Mineral Economics

 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
An option valuation lattice is then constructed as shown in
Table 12.4, by first determining in column 5 under which
combinations of ups and downs it would be optimal to expand.
For instance, expansion is warranted in the case of five ups, four
ups and one down and three ups and two downs, because 1.6
times the relevant value of the underlying asset at $60 million
less the implementation cost of $40 million is greater than the
value of not expanding, ie:
1.6 * 345.28 – 40 = 512.44 > 345.28
similarly for 234.33 versus 171.46 and 96.23 versus 85.14. From
two up three down to five down the value of expanding is lower
than continuing with the single mill and the expansion option is
consequently let to expire.
The next step is to roll back the values in the option valuation
lattice from right to left starting from the step 5 column. For
instance 352.0 in step 4 is obtained by applying the ‘risk-free’
probability (p) to 512.4 and (1-p) to 234.3 and then by
discounting by one year as follows:
(512.44 * 0.515 + 234.33 * (1 – 0.515)) * exp(- 0.07 * 10.5) = 352.00
where:
exp(- r * square root of (∆t)) = exp (- 0.07 * 10.5) = 0.93239 is the
continuous time discount factor at a rate of seven per cent per
annum, ie for ∆t = 1
As each pair of figures in each column is rolled back to the left
in a similar manner, the combined value (or expanded net present
value (ENPV)) of $63.0 million is easily obtained. The difference
between the ENPV at $63.0 million and the basic NPV of the
project prior to expansion (ie $60 million), amounting to $3
million, is the real option value (ROV) of a possible, currently
uneconomic, 60 per cent mill capacity expansion.
This type of lattice can be done relatively simply using a
personal computer spreadsheet as shown in Table 12.4, but more
complex options may require specialised software which also
allows the construction of more accurate, multi-step lattices with
greater granularity (Mun, 2002, p 154).
VALUING TONNAGE-GRADE TRADE-OFFS
Analysts are often required to capture the option value of projects
with significant potential grade-tonnages trade-offs. Traditional
JORC code-based DCF/NPV valuations, including only proven
and probable ‘run-of-the-mill’ reserves, generally do not recognise
managerial flexibility and the price leverage inherent in these
reserves and in the surrounding halo of lower grade resources.
They, therefore grossly undervalue such projects.
A number of sophisticated models to assess the optimal timing
for expansion, contraction and abandonment of mining projects
as a function of commodity prices have been developed
following the paper by Brennan and Schwartz (1985). These
include, among others, modelling the price, cost and reserves
uncertainty of a generic copper mine by Cortazar and Casassus
(1998) and by Poulin, Samis and Laughton (2001) and of the
East Rand gold mine by Samis (1995).
Figure 12.13, which has been adapted from Samis (2002),
displays the possible payoffs for the options inherent in a mining
project with a small core of high-grade reserves, within a large
volume of ‘run-of-the-mill’ ore, adjacent to a significant
low-grade resource. Grade-tannages trade-offs give rise to what
is known as a multiple or chooser option (Mun, 2002, p 181), as
the investor can choose among more than one possible course of
actions at any one time.
At a commodity price below A the project is subeconomic and
development would be delayed or if the mine is currently
operating it should close. If prices rise above A it becomes
justifiable to develop the project to mine the high-grade core. As
Australian Mineral Economics
FIG 12.13 - Multiple (chooser) real options due to grade-tonnage
trade-offs in mining (after Samis, 2002).
prices continue to rise the project becomes increasingly more
profitable until when prices exceed B, it is financially justifiable
to mine ‘run-of-the-mill’ grade ore. When prices rise above C an
expansion of production to the low-grade ore is optimal.
Let us consider the options open to the manager of a mining
operation worth $100 million, which is currently producing
‘run-of-the-mill’ ore. Further assume that for five years,
depending on the direction and severity of commodity prices
changes, he or she can:
1. continue to mine ‘run-of-the-mill’ ore requiring no capital
investment;
2. expand production by 30 per cent by mining lower grade
ore at a capital cost of $20 million;
3. contract production by ten per cent by mining high-grade
current ore reserves at a saving of $25 million; or
4. abandon production and sell the project for $85 million.
Table 12.5 shows that this chooser option would add $17.3
million to the $100 million static NPV of this project even at a
modest level of 15 per cent volatility in the cash flows of the
project and at a risk-free rate of interest of five per cent.
The process in Figure 12.13 is the same as that used in the
previous expansion model as far as the lattice of values of
possible outcomes is concerned, but uses a different
maximisation rule to determine the end members of the lattice of
option values, ie:
Max (continue, expand, contract, abandon)
Thus, the expansion option is the most valuable outcome in the
case of five successive up states of nature, as it is higher than the
value of the underlying asset under the same states of nature but
without expansion, ie:
[(value of underlying asset if five ups occur) * (1 + expansion
factor)] - implementation cost = (($211.7 M * (1 + 30 per cent)) -
$20 M) = $255.2 M is higher than
(present value of project in year 0) * (up factor compound over
five years) = $100 M * exp(σ * T 0.5) 5 = $211.7 M
As a matter of fact the value of the expansion option under
these states of nature is higher than any of the other options open
to the investor. The option value lattice of Figure 12.13 shows the
expansion option has the maximum value even if there are four
ups and one down (ie $183.9 million) or three ups and two downs
(ie $131.0 million), after which the contract option produces the
maximum value (ie $102.5 million). In the case of one up and
four downs and five down, the course of action that maximises
value is to sell the project for $85 million.
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TABLE 12.5
Estimating the value of a miner’s chooser option to expand, contract or abandon production.
Chooser option binomial lattice
Continue Expand Contract Abandon
Change in NPV 0.00% 30.00% -10.00% -100.00%
Asset value ($) 100 Stepping time (dt) 1
Implementation cost ($) 0 20 -25 -85 Up-step size (up) 1.162
Maturity (years) 5 Down-step size (down) 0.861
Risk-free rate (%) 5.00% Risk-neutral probability (p) 0.633
Dividend (%) 0.00%
Volatility (%) 15.00%
Lattice steps 5
Time 0 1 2 3 4 5
Possible outcomes
Certain u 2u 3u 4u 5u
d du d2u d3u d4u
2d 2du 2d2u 2d3u
3d 3du 3d2u
4d 4du
5d
Value of possible outcomes
100.0 116.2 135.0 156.8 182.2 211.7
86.1 100.0 116.2 135.0 156.8
74.1 86.1 100.0 116.2
63.8 74.1 86.1
54.9 63.8
47.2
Expanded NPV including option value
117.3 136.1 158.7 185.8 217.9 255.2 Expand
101.2 116.1 134.2 156.5 183.9 Expand
89.8 100.9 114.7 131.0 Expand
83.2 91.4 102.5 Contract
80.9 85.0 Abandon
85.0 Abandon

The roll back process then involves the progressive application
of risk-free probability and continuous discounting for timing as
in the expansion option of Table 12.4.
This chooser option value of $117.3 M - $100 M = $17.3 M is
not the equivalent to the sum of the individual single options to
expand, contract or/and abandon, but is derived as a chooser
option combination of the three.
This model as well as option models previously discussed,
however, would determine a fair project value while the option is
open, they do not imply that the project maintains this value at
any stage after any of the multiple options is exercised. For
instance if the expansion option were exercised after price
increases, then the mine owner would only have the option to
regress to mining ‘run-of-mill’ ore or abandon. This chooser
option would have a vastly different value. A higher level of
complexity is also created by the fact that, in real life, all of these
options should also be reversible and that management generally
has the flexibility of placing from time to time the mine on care
and maintenance when price falls make it uneconomic to operate.
This type of option is addressed in Slade’s (2001) model of all
the Canadian copper mines operating between 1980 and 1993,
which includes a facility, albeit mathematically complex, to value
the option of implementing temporary suspension and resumption
of production in response to changes in commodity prices.
A discussion on how to overcome the conceptual complexity and
computational difficulty in recognising and modelling such
switching options is, however, well beyond the scope of this paper.
EVALUATING THE SEQUENTIAL AND
COMPOUND REAL OPTION VALUE OF
MINERAL EXPLORATION FARM-IN/
OPTIONS AGREEMENTS
A real option is said to be:
• compound when its value is contingent on two interacting
optional decisions with the same expiry term; and
• sequential and compound when there is a series of
chronologically sequential decision (eg project stages) where
each decision is conditional on a previous one.
Sequential/compound options are typical of multi-stage
projects, where progress to successive stages is dependent on the
outcome of preceding ones. For example, mining entails:
• mineral exploration;
• if exploration is successful, then resources delineation and
feasibility studies follow, otherwise the project is relinquished;

146 Australian Mineral Economics

 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK

TABLE 12.6
Evaluation of the sequential/compound option inherent in a mineral exploration farm-in agreement.

Binomial lattice using the risk-free probability method

Sequential two-stages three- and one-year options
Three-year option 2
Asset value ($) 5 Stepping-time (dt) 1
Implementation cost (X2) ($ M) 7 Up-step size (up) 1.492
Maturity T2 (years) 3 Down-step size (down) 0.670
Risk-free rate (%) 7.00% Risk-neutral probability (p) 0.490
Dividend (%) 0.00%
Volatility (%) 40.00%
Lattice steps for option 2 3.00
Time 0 Step 1 Step 2 Step 3
Value of possible outcomes for underlying asset
5.0 7.5 11.1 16.6
3.4 5.0 7.5
2.2 3.4
1.5
Option 2 value disregarding option 1
1.0 2.2 4.6 9.6
0.1 0.2 0.5
0.0 0.0
0.0
One-year option 1
Implementation cost (X1) ($ M) 0.56 Option 1
Maturity T1 (years) 1 Option 2
Lattice steps for option 1 1.00
First year values of option 2 are used as underlying assets for option 1, which are then rolled back to their present
value ROV
Sequential/compound ROV 0.7 1.6 4.6 9.6
0.0 0.2 0.5
0.0 0.0
0.0
Decisions
Open Invest in 1 Open Invest in 2
Do not invest Open Invest in 2
Do not invest Do not invest
Do not invest

• if feasibility is demonstrated then construction and
development of the mine can take place, otherwise the
project is mothballed; and
• only if all the above is realised will the mine progress to the
production stage.
At the conclusion of each successive phase of an exploration
program, for instance, explorers have the option but not the
obligation to:
• progress to the next stage;
• defer further exploration if they can hang onto the
exploration license at low cost;
• farm-out part of the project to an interested potential joint
venture participant; or
• abandon the project.
Lets consider the example of an exploration company, which is
offered the following farm-in option:
• by funding statutory exploration commitments amounting to
$30 000 it can carry out surficial exploration and shallow
RAB drilling for one year;
• at the end of year 1, by paying $0.5 million and guaranteeing
funding of statutory expenditure commitments for the next
two years, it acquires the right but not the obligation to drill
test the project over the following two years; and
• at the end of year 3 the company can acquire 100 per cent equity
in the project by paying $7 M or walk away with no penalty.
The project is the only asset held by a junior company, which
is debt-free, has little cash in the bank and is capitalised at $5 M.
It has been estimated that the average volatility of return on
holding stock of similar single-project, junior exploration
companies under foreseeable market conditions is 40 per cent.
Following an example provided by Mun (2002, p 191) we can
generate the lattice of possible asset values and the option value
lattices for the two component options as shown in Table 12.6.
For instance, the capitalisation of the company holding the

Australian Mineral Economics 147

CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
project, and therefore the value of the project, could range
between $16.6 million if the up state is realised three times in
succession and $1.5 million if the down state occurs in three
successive years. The applicable risk-free rate is seven per cent.
The binomial lattice for the longest-term component option
must first be constructed, ie the three-year’s term, 100 per cent
acquisition stage, as if exploration had been successful justifying
final exercise of this option. The value of this simple call option
would be $1.0 million as shown in Table 12.6.
We then need to superimposed on it the shorter-term (one year)
component option, ie the option to drill test the project taking into
account its implementation cost at the end of year 1 of $0.5 M
payment plus $60 000 in statutory expenditure commitments. The
underlying asset values for option 1 are the values in the year 1
column of option 2. These are rolled back to their present value
ROV as usual using the risk-free probability and continuous
discount factor.
From Table 12.6 it can be seen that the combined present value
of the sequential/compound mineral exploration farm-in option is
$0.7 million. The model allows for the sensitivity of this ROV
value to be tested in different combinations of option payments
and volatilities of returns and can thus assist in conducting better
informed negotiations.
The model could also be easily modified to evaluate a joint
venture farm-in by changing its current 100 per cent equity
acquisition to any desired lower proportion of equity in the project.
STRATEGIC ROV CONSIDERATIONS
Recognising and correctly estimating the value of real options
has significant strategic value. Analysts in the petroleum industry
have been the first to recognise and take advantage of these
powerful techniques.
Lesley and Michaels (1997) for instance describe how British
Petroleum (BP) made significant use of ROV when carrying out
a rationalisation of its North Sea oil tenements at times of
relatively low oil prices. Their real option valuations militated
against relinquishing a number licenses which were subeconomic
at the time but which, with the wisdom of hindsight, proved to be
very valuable.
Smith and McCardle (1999) and Claeys and Walkup (1999)
suggest ways to recognise option values in oil projects, while
Faiz (2001) discusses possible approaches to integrate ROV in
the strategic planning and optimisation strategy of a large
integrated oil company.
In the last few years precious metals analysts have made
systematic use of real option valuations to explain the equity
premium on the share price of gold and platinum-group
metal-producing companies (Morgan, 2005; Dinham, 2005).
Of particular interest is the recent application by Flores (2004)
of binomial lattices and risk-free probabilities to estimate the
value of gold exploration projects.
Asides from brokers, there have been relatively few published
practical applications of ROV to the mineral exploration and
mining industry in spite of the appearance of several academic
papers on the subject. This may not mean that such studies and
applications are not carried out in the industrial arena, but may
just be the reflection of the highly proprietary and confidential
nature of these studies.
As the saying goes ‘mines are not found, they are made’.
Many successful mines have been developed on the ashes of
previous unsuccessful attempts. The main challenge is in
recognising the real options inherent in a project that current
owners have failed to spot.
Invariably the price expectations in the mind of the frustrated
and risk-averse owners of projects, which are sub-economic at
current prices, tend to be low. This generates realistic
opportunities for acquisition and value adding through more
creative and flexible design, application of emerging technology
and innovative financing.
148
While the ROV methodology is generally complex and
relevant skills scarce or proprietary at this stage, the cost of
carrying out a ROV evaluation model is relatively low compared
to significant leverage in terms of value added.
It is also fallacious to consider that ROV is the exclusive realm
of financial analysts. Value is added primarily by the recognition
of potential real options in a project, which by and large depends
on good geological, mining engineering and metallurgical
analytical skills.
Furthermore, there is initially no need to construct an
extraordinarily complex model, as an initial indication of whether
there could be ROV and of its order of magnitude may be obtained
with a simplified model provided its structure is sound.
Finally, even in the development of new mineral resources, a
degree of knowledge of ROV methodology on the side of design
engineers will lead to more flexible and therefore more robust
designs, capable of better withstanding some of the hard times
that inevitably any mining operation will cross over its life.
The strategic advantage of mastering ROV will, in the opinion
of the author, soon be better recognised by shrewd operators in
the mining industry in shaping both their acquisitive and
divestment strategies.
A further significant challenge in real option evaluations
frequently arises from the resistance on the side of management
to accept the result of ROV analyses if they do not have a degree
of familiarity with this methodology. In absence of some
understanding it becomes very difficult for the analyst to explain
the methodology and to communicate the results in simple
language often under severe time constraints. It seems likely that
communication problems may have been the main cause for the
relatively slow rate of acceptance up to date of this otherwise
powerful and more realistic way of valuing mining projects.
Much can and should be done to demystify the subject and
increase understanding and acceptance. It is hoped that this paper
may facilitate this process.
CONCLUSIONS
In summary, it can be concluded that:
1. Discounted cash flow (DCF) analysis will continue to
provide valid decision-making criteria if a project has low
expected cash flow volatility and low management
flexibility.
2. Investment decisions based on risk-neutral maximisation of
expected monetary values (EMV) are unrealistic in most
circumstances and greater awareness and use should be
made of risk-averse investment criteria based on expected
preference values or certainty equivalents (Cx).
3. DCF analysis may introduce bias and at times severe
distortion, particularly when valuing financially marginal
projects based on very price-volatile commodities. The
reasons for this are manyfold and include the application of
a single risk- and time-adjusted discount rate:
a. to compare projects with inherently very different risk
characteristics; and
b. simultaneously to the revenue of a project, which is
generally subject to considerable price risk beyond
management control, and to its less risky and more
controllable cost function.
4. Deterministic DCF analysis does not capture the value of
managerial flexibility to adjust their decisions and actions as
new information progressively dispels uncertainty during the
unfolding of the project. Managerial flexibility has all the
characteristics of a real option to take actions beneficial to
the firm with the wisdom of hindsight and avoid negative
outcomes.
Australian Mineral Economics
 CHAPTER 12: MINERAL PROJECT EVALUATION — DEALING WITH UNCERTAINTY AND RISK
5. Methods for the valuation of financial derivatives can be
effectively adapted to the valuation of ‘real options’
inherent or deliberately planned in risky resources projects.
6. A deterministic DCF/NPV model of the project (asset)
underlying a real option can be used to circumvent the lack
of frequent trading in the project and to derive the volatility
of its cash flows as the main inputs necessary to build a real
option model of the project.
7. Of the various methods to value real options, the use of
binomial lattices whether solved using ‘risk-free’
probabilities or ‘state prices’ is generally the most friendly
and versatile approach. A binomial lattice model bypasses
many of the unrealistic assumptions and limitations
inherent in the use of closed-form equations (eg Black and
Scholes formula) to derive a project ROV as well as the
mathematical complexity of stochastic calculus and/or
partial-differential-equation-based models.
8. Communicating in simple language and in a persuasive
manner the methodology and results of a ROV analysis to
unfamiliar decision-makers is a major challenge and
probably one of the main causes of the relatively slow rate of
penetration and acceptance of this analytical tool in everyday
practice in the mineral exploration and mining sector.
REFERENCES
Baker, M P, Mayfield, E S and Parson, J E, 1998. Alternative models of
uncertain commodity prices for use with modern asset pricing
methods, The Energy Journal, 19(1):115-148.
Benninga, S Z, 2000. Financial Modelling, second edition (The MIT
Press: Cambridge).
Bradley, P G, 1998. On the use of MAP for comparing alternative royalty
systems for petroleum development projects, The Energy Journal,
19(1):47-82.
Brennan, M and Schwartz, E, 1985. Evaluating natural resources
investment, Journal of Business, 58(2):135-157.
Burn, R G, 1984. Exploration risk, CIM Bulletin, October, pp 55-61.
Claeys, J and Walkup, G, 1999. Discovering real options in oilfields
exploration and development, in Proceedings SPE Hydrocarbon
Economics and Evaluation Symposium (Society of Petroleum
Engineers: Dallas).
Copeland, T and Antikarov, V, 2003. Real Options (Texere LLC: New York).
Copeland, T and Keenan, P T, 1998. How much is flexibility worth? The
McKinsey Quarterly, 2:38-49.
Cortazar, G and Casassus, J, 1998. Optimal timing of a mine expansion:
Implementing a real option model, The Quarterly Review of
Economics and Finance, 38:755-769.
Dias, M A G, 2002. Stochastic processes with focus in petroleum
applications [online]. Available from: <http://www.puc-rio.br/marco.
ind/stochast.html>. Date accessed 8 May 2006.
Dinham, N, 2005. Platinum sector: new valuation method, Andisa
Securities, 22 April 2005.
Dixit, A K and Pindyck, R S, 1995. The options approach to capital
investment, Harvard Business Review, 73(3):105-115.
Etheridge, M and Uttley, P, 2003. Uncertainty, decision-making and value
measurement – The fundamentals of the business of exploration,
presented at Risk Analysis and Management in Mineral Exploration
and Development Seminar, November (The Australian Institute of
Geoscientists: Perth).
Faiz, S, 2001. Real-options application: from successes in asset valuation
to challenges for an enterprisewide approach, Journal of Petroleum
Technology, 53(1):42-47. Available from: <http://www.spe.org/
elibinfo/eJournal_Papers/spe/2001/JPT/01/00068243/00068243.htm>
Date accessed: 8 May 2006.
Flores, V, 2004. Standing on a gold mine? HSBC Global Research,
Precious Metals, December 2004.
Hayward, N, 2003. Risk behaviours and intuition traps, presented at Risk
Analysis and Management in Mineral Exploration and Development
Seminar, November (The Australian Institute of Geoscientists: Perth).
Australian Mineral Economics
JORC, 2004. Australasian Code for Reporting of Mineral Resources and
Ore Reserves (The JORC Code), The Joint Ore Reserves Committee
of The Australasian Institute of Mining and Metallurgy, Australian
Institute of Geoscientists and Minerals Council of Australia. [Online].
Available from: <http://www.ausimm.com/codes/jorc0105.pdf>. Date
accessed: 8 May 2006.
Laughton, D G, 1998. The potential for use of the modern asset pricing
methods for upstream petroleum project evaluation: introductory
remarks, The Energy Journal, 19(1):1-11.
Lawrence, R D, 2001. Should discounted cash flow projections for the
determination of fair market value be based solely on proven and
probable reserves? Mining Engineering, 53(4):51-56.
Lesley, K J and Michaels, M P, 1997. The real power of real options, The
McKinsey Quarterly, 3:4-24.
Lord, D, Etheridge, M and Uttley, P, 2003. Risk and value in mineral
exploration – Case studies on the application of risk analysis,
presented at Risk Analysis and Management in Mineral Exploration
and Development Seminar, November (The Australian Institute of
Geoscientists: Perth).
Morgan, J P, 2005. South African gold and platinum sector update,
African Equity Research, 10 May 2005.
Mun, J, 2002. Real Options Analysis: Tools and Techniques for Valuing
Strategic Investments and Decisions (John Wiley: Hoboken).
Peirson, G, Brown, R, Easton, S and Howard, P, 2002. Business Finance,
eighth edition (McGraw-Hill Irwin: New York).
Poulin, R, Samis, M R and Laughton, D G, 2001. Valuing a multi-zone
mine as a real asset portfolio: a modern asset pricing (real option)
approach, Corporate Finance Abstracts: Valuation, Capital Budgeting
and Investment Policy Working Paper Series, pp 4-29.
Salahor, G, 1998. Implications of output price risk and operating leverage
for the evaluation of petroleum development projects, The Energy
Journal, 19(1):13-46.
Samis, M R, 1995. An option pricing analysis of the 1990 capital structure
of the East Rand proprietary mine, in Proceedings CAMI 95 – Third
Canadian Conference on Computer Applications in the Mineral
Industry, (ed: H S Mitri) (McGill University Press: Montreal).
Samis, M R, 2002. Resources sector finance 602, 2002 course notes
(Western Australian School of Mines: Kalgoorlie).
Schodde, R, 2005. Personal communication.
Slade, M E, 2001. Valuing managerial flexibility: an application of real
option theory to mining investments, Journal of Environmental
Economics and Management, 41:193-233.
Smith, J and McCardle, K, 1999. Options in the real world: lessons learned
in evaluating oil and gas investments, Operations Research, 47:1-15.
VALMIN, 2005. Code for the Technical Assessment and Valuation of
Mineral and Petroleum Assets and Securities for Independent Expert
Reports (The VALMIN Code), The VALMIN Committee, a joint
committee of The Australasian Institute of Mining and Metallurgy,
the Australian Institute of Geoscientists and the Mineral Industry
Consultants Association (The Australasian Institute of Mining and
Metallurgy). [Online]. Available from: <http://www.ausimm.com/
codes/valmin_2005.pdf>. Date accessed: 8 May 2006.
FURTHER READING
Amram, M and Kulatilaka, N, 1999. Real Options: Managing Strategic
Investment in an Uncertain World (Harvard Business Press: Boston).
Guj, P, 2004. Resources sector finance 602, 2004 course notes (Western
Australian School of Mines: Kalgoorlie).
Jacoby, H and Laughton, D, 1992. Project evaluation: a practical asset
pricing method, The Energy Journal, 13:19-47.
Laughton, D G, 1998. The management of flexibility in the upstream
petroleum industry, The Energy Journal, 19(1):83-114.
Luehrman, T A, 1998a. Investment opportunities as real options: getting
started on the numbers, Harvard Business Review, July-August.
Luehrman, T A, 1998b. Strategy as a portfolio of real options, Harvard
Business Review, September-October.
Samis, M R, 2000. Multi-zone mine valuation using modern asset pricing
(real options) techniques, unpublished PhD dissertation, University
of British Columbia.
Samis, M R and Davis, G A, 2004. Actively recognising cash flow
uncertainty within the net present value calculation, MEMS Newsletter,
31, winter.
149

Mineral Policy — An Introduction
Philip Maxwell and Pietro Guj
The Aims and Practice of Economic Policy
The Context of Mineral Policy
Mineral Policy in Practice
The Transition of Mineral Policy since 1950
THE AIMS AND PRACTICE OF ECONOMIC
POLICY
From the viewpoint of policymakers and citizens more generally,
the most desirable state of society is a situation where there is
maximum economic and social wellbeing.
Randall (1987, p 132) describes this as:
A condition in which society is as well off as it
can possibly be, given its resource base, its
productive technology and the tastes and
preferences of its members.
It is possible to describe this in a very simple static welfare
economics framework in terms of the production possibility/
community indifference curve diagram shown in Figure 13.1.
Recall that the production possibility curve shows different
maximum combinations of goods and services that society can
produce if all factors of production are fully employed during a
given period. With less than full employment of all factors of
production, society will operate below the curve.
Goods Community
indifference
curves
E
CIC3
CIC2
Production
possibility CIC1
curve
Services
FIG 13.1 - Maximising society wellbeing.
1. These curves implicitly assume a given distribution of income.
Australian Mineral Economics
CHAPTER 13
It is not possible to produce above (to the right of) the
production possibility curve, given the limited factors of
production available and the current state of technology.
In this simple view of the world, a series of community
indifference curves can also be drawn that show different
combinations of goods and services corresponding to the same
level of welfare1. As we move from CIC1 to CIC2 to CIC3 the level
of consumer welfare is increasing. Society will strive to reach the
highest community indifference curve, with its current production
possibility curve. This is achieved at the point E where the
production possibility curve just touches (is tangential to) CIC2.
The role of government in society is to seek to ensure that
society reaches this point and stays there over time.
The real world differs in complexity and detail from this simple
static world. In countries with capitalist economic systems such as
Australia, government operates in a dynamic and uncertain
environment seeking to balance production, distribution and
sustainability. Following Waud et al (1996, pp 65-78), we note that
government performs four main functions:
1. managing a legal and institutional structure in which
markets operate;
2. intervening in the allocation of resources in areas where
public policy deems it beneficial to do so;
3. seeking to provide stability in economic conditions; and
4. redistributing income and wealth.
The three levels of government in Australia – federal, state and
local – share these roles.
While it is instructive to discuss these functions in little further
detail at this point, the authors of the following two chapters
focus on the first two areas as they relate particularly to
Australia’s minerals and energy sector.
In Australia, government manages the legal and regulatory
structure in which markets operate in a variety of ways. Its
various branches are responsible for areas such as:
• trade practices legislation,
• environmental protection legislation,
• marketing schemes and subsidies for primary producers,
153
CHAPTER 13: MINERAL POLICY — AN INTRODUCTION

• tax concessions and development restraints in mining,
• tariff and quota protection in manufacturing,
• legislation regulating the operation of the financial sector,
• legislation regulating mining operations,
• ensuring occupational and community health and safety
standard,
and the list goes on.
It allocates resources through its spending activities, its tax
policies, and its own production of certain goods and services.
The first two of these areas – spending and taxation – are the key
elements of fiscal policy. The third involves operating public
enterprises in ‘natural monopoly’ situations. In Australia this has
traditionally covered areas such as provision of water, gas,
electricity, postal services, telecommunications and even
financial institutions. In recent decades there has been a major
movement towards commercialisation and privatisation of these
areas. Government is also a major provider of education and
health services.
Governments seek to provide stability in economic
conditions in areas such as prices, employment, economic
growth, external viability and economic conditions generally.
Sound economic management, which inspires confidence in the
economy by the private sector and the outside world, is necessary
to achieve this outcome.
Finally, government pursues objectives of social equity and
redistributes income and wealth. In developed nations such as
Australia, this occurs largely through applying progressive rates
of income tax and wealth-related taxes, and using the social
security system to provide age and disability pensions, child
endowment, unemployment benefit payments and in areas such
as support for single parents and needy students undertaking
post-secondary education. It also takes place through the
preferential tax treatment of the superannuation system, which
requires workers to save for their retirement years.
Any government’s current policy stance will reflect its efforts
to achieve maximum economic and social wellbeing, given the
political ideologies of its constituency. For example, a Labor
party government at Federal or State level in Australia will
typically seek an equitable distribution of income and wealth
entailing greater equality as a higher priority than a conservative
government. Its policy settings will seek to achieve this outcome.
THE CONTEXT OF MINERAL POLICY
Governments use a range of policy instruments (tools) to achieve
their objectives. The typical list includes:
2. It has been assumed that mines also include oil and gas wells in the
context of this discussion. This view is consistent with the definition
of mining used by the Australian Bureau of Statistics (2005, p 493).
• fiscal policy (varying and directing government expenditure,
and raising and lowering taxes);
• monetary policy (setting interest rates);
• exchange rate policy (setting exchange rates at fixed rates
relative to other currencies or letting them float);
• tariff policy (using a range of policies to facilitate or restrain
international trade);
• wages policy (setting minimum wages); and
• environmental policy (setting emission standards for
factories to discharge wastes into the air, nearby landfills,
rivers and the sea, establishing and maintaining wilderness
areas and rules about land use).
It is also common to see a national or state government’s
policy stance described in terms of a set of policy tool settings
applied to particular industry sectors. Hence reference to
agricultural policy, mineral policy, manufacturing policy,
transport policy, communications policy, health policy, education
policy, tourism policy and so on, can be seen. These policies,
which are sometimes described formally in published
documents, typically reflect economic, social and political views.
It is convenient to think of policy settings in a matrix format in
which some or all of the elements of a government’s policy tools
are applied to influence the performance of different industry
sectors. The checked boxes in the simple matrix in Table 13.1
provide one classification of how some policy tools directly
affect particular sectors.
Any nation’s or region’s mineral policy should in general
terms be concerned with the rational development of mineral and
energy resources to achieve the broad economic goals of
government and society.
This policy involves a combination of fiscal, exchange rate,
tariff, wages, specific occupational health and safety, and
environmental policies. The typical list of economic goals includes
high (or full) employment, price stability, sustainable economic
growth over time, external stability, a clean and safe environment,
an equitable distribution of income, an equitable taxation system,
economic security and economic freedom. Some of the key fiscal
aspects of a mineral policy relate to the application of mineral
taxes and royalties, which will be examined more closely in
Chapter 14.
It is instructive also to recall Garnaut’s five key characteristics
of mines2 (Garnaut, 1995) mentioned previously in Chapter 1.
These are that:
1. they can generate economic rent;
2. they are often established most efficiently on a very large scale;
3. their development is often highly capital intensive;
4. they have unusually large local environmental, social and
economic impacts; and

TABLE 13.1
The application of economic policy instruments in industry sector policies.
Policy instruments
Fiscal Monetary Exchange rate Tariff Wage Environmental
Agricultural x x x x x
Mineral x x x x x
Manufacturing x x x x
Health x x
Education x x
Housing x x x
Tourism x x x x

154 Australian Mineral Economics


5. their national economic impact varies greatly over
relatively short periods of time.
The concept of mineral rent was introduced in Chapter 3 and
Frank Harman and Pietro Guj discuss the concept in considerable
detail in Chapter 15. It is useful to briefly review the meaning of
the concept again at this point. Economic rent is the payment that
any resource receives in excess of its supply price where there is
a market equilibrium. Mineral rents are one type of economic
rent.
As was seen in Chapter 3, Garnaut and Clunies Ross (1983)
provide the following definition:
Mineral rent may be defined as the returns in
excess of those needed to attract factors of
production into the mining industry in the long
run. It is the revenue remaining after all costs
have been deducted. These costs include
exploration outlays, expenditures on mine
establishment and cash operating costs. Unlike
the accountant’s notion of costs, economic costs
include the returns on capital invested which are
just sufficient to attract the capital to the
enterprise.
It could be argued that government can, in principle, tax rent
away without reducing economic output. It is therefore an
attractive source of potential public revenue in any mineral rich
economy. But as Garnaut (1995) also notes, stakeholders who
have veto power over mine (and oil well) development, also have
the ability or potential ability to access economic rent.
Furthermore such rent:
can be dissipated by uncertainty as conflict
between holders of the veto power raises the
supply prices of inputs into production.
Garnaut’s second and third points relate to the large scale and
capital intensity of the modern formal mining sector. Many new
mining ventures, often in remote areas, involve investments of
hundreds of millions or even billions of dollars. Western
Australian nickel mining ventures such as Murrin Murrin, Mount
Keith and Ravensthorpe, and the poly-metallic Olympic Dam
mine in South Australia are good examples of large-scale,
capital-intensive mines. There are many other such mines around
the world. They include copper mines such as Escondida and
Collahuasi in Chile, the Yanacocha gold mine in Peru, the Ekati
and Diavik diamond mines and the Voisey’s Bay nickel mine in
Arctic Canada, the Grasberg copper/gold mine in Indonesia and
the Porgera gold mine in Papua New Guinea. These are large,
long-life mines in which the capital investment per employed
worker is very high.
The environmental, social and economic impacts in local
areas near to a new mine, or in the surrounding state or region,
can be dramatic, although the extent of these impacts has
recently been affected significantly by the continued growth of
fly-in, fly-out work practices3. They are particular dramatic when
they disrupt the lifestyles and livelihoods of residents of the
mining area, particularly if these people have a long traditional
association with the local area. Attention by large mining
companies to world-class environmental practice, even in poor
developing nations, is now a major issue, as is the pursuit of
sustainability strategies to assist local populations once a mine
has closed.
The volatility of national and regional impacts over
relatively short periods is also an important issue. This is
particularly the case for developing nations, or even smaller
regions or states in developed nations such as Australia or
Canada. New mining ventures will significantly increase the
3. These impacts are also discussed in Chapter 8 and Chapter 18.
Australian Mineral Economics
CHAPTER 13: MINERAL POLICY — AN INTRODUCTION
gross product of a nation or region in a short time period. But
their closure will also dramatically reduce local incomes unless
there is a sustainable alternative economy in place.
In the late 1980s for example, new mineral developments
seemed to have the potential to more than triple the Gross
Domestic Product of Papua New Guinea within five years. This
did not happen, in part because of the sudden closure of the large
Panguna copper mine in the middle of 1989 when a civil war
erupted. In combination with relatively wide movements in the
price of gold and copper, there has been considerable uncertainty
and difficulty in managing the Papua New Guinea economy over
the past 15 years.
MINERAL POLICY IN PRACTICE
As just noted, any nation’s or region’s mineral policy should be
concerned with the rational development of mineral and energy
resources to achieve the broad economic goals of government. In
Chapters 2 and 3 the soundness of such development was
discussed, while giving consideration to the recent debate about
whether resources are a blessing or a curse. Notwithstanding the
position one takes in this debate, it is likely that the citizens of
any nation or region, that possesses a significant mineral
endowment, will wish to extract that endowment in the cause of
national development.
In seeking to do this effectively, policymakers are operating in
a competitive environment where they aim to maximise the net
present value of all future benefits derived from mining (Tilton,
2004, p 147). This will typically involve objectives such as job
creation, regional development and sustaining the viability of the
mining industry over time by encouraging exploration for new
deposits. It is unlikely to coincide with maximising the rent
extracted.
Determining the optimal proportion of the rents appropriate to
achieve optimality is not an easy task. Any mineral policy
position will depend on the collective view of government about
the relative desirability and efficiency of the private and public
sectors. It will also depend on where government places a
‘ring-fence’ in terms of the social and economic impact of its
policies. This issue relates to the ways in which the benefits
should be shared by the nation, regions and local communities
directly affected by the mine or oil or gas well, as well as on time
preferences in terms of inter-generational equity.
While an optimal allocation of resources within a geographic
area ensures economic efficiency, ie for those sectors of the
economy that given a certain level of income generate the
greatest output of goods and services that society demands, it
does not necessarily ensure economic equity. With change there
will always be differential impacts on various sectors of society,
in other words winners and losers. This generates political
tension and, because governments wish to be re-elected, in
practice economic policy change is seldom if ever optimal but
seeks second-best solutions. Government economic policy is
generally influenced by the Pareto optimality principle that
reallocation of resources should only proceed if at least one
sector is better off while none is worse off. More frequently the
Kaldor-Hicks criterion applies whereby if some sectors are worse
off, then re-allocation of resources should only proceed if the
overall benefit from it is large enough for the negatively affected
parties to be compensated so they are not disadvantaged, while
still achieving an aggregate level of societal benefit which is
higher than if re-allocation had not taken place.
The objectives of private companies will never completely
coincide with the aims of government. The former must serve the
needs of shareholders, their financial backers and their workforce
while the latter represents the interests of the broader
community. One way of perceiving this is in terms of Figure
13.2. The extent of overlap between company and community
155
CHAPTER 13: MINERAL POLICY — AN INTRODUCTION

Government Mining/Exploration companies TABLE 13.2

Company rankings of investment criteria for mineral exploration
Optimisation of Maximising shareholder
and mine investment stage (out of a choice of 60 possible criteria).
community benefits benefits Source: derived from survey conducted by Otto (1992), reproduced
in Otto (2005).
Ranking Decision criteria based on
Exploration Mining
Trade Common Trade stage stage
offs ground offs
1 na Geological potential for target mineral
na 3 Measure of profitability
2 1 Security of tenure
Economic, social Market 3 2 Ability to repatriate profits
& political forces forces 4 9 Consistency and constancy of mineral policies
5 7 Company has management control
6 11 Mineral ownership
FIG 13.2 - The coincidence and divergence of public and private
strategic objectives. 7 6 Realistic foreign exchange regulations
8 4 Stability of exploration/mining terms
goals is likely to be greater if large numbers of shareholders live 9 5 Ability to predetermine tax liability
in the area in which a mining company has its operations. Yet,
10 8 Ability to predetermine environmental
where this does not occur, professional managers will recognise obligations
the necessity of being ‘good corporate citizens’ to maintain their
‘licence to operate’ within the region, the nation and even 11 10 Stability of fiscal regime
globally over extended periods. 12 12 Ability to raise external financing
There is, of course the option for governments to choose to 13 16 Long-term national stability
develop mineral resources themselves. In this way there could 14 17 Established mineral titles system
be, at least in theory, a complete correspondence between
15 na Ability to apply geological assessment
company and government objectives. The difficulty with this
techniques
strategy is that such public enterprises are usually less efficient
and effective than those that are privately owned. While this may 16 13 Method and level of tax levies
be due in part to political influences, governments in developing 17 15 Import-export policies
nations often do not have access to sufficient investment funds 18 18 Majority equity ownership held by
for new resource developments. It is no surprise, therefore, that company
there has been a recent trend have been towards privatisation of
19 21 Right to transfer ownership
government trading enterprises.
The challenge for any nation, state or region is to develop a 20 20 Internal (armed) conflicts
policy structure that attracts investment and also ensures that its 21 14 Permitted external accounts
policy objectives are achieved. This requires a clearly understood 22 19 Modern mineral legislation
regulatory framework, which may be underpinned by a formal
mineral policy document4. While specific mining legislation is na: not applicable
an important part of this, a variety of other laws relating to land, Note: decision criteria appearing in bold typeface may be controlled or
taxation, imports and exports, water, foreign investment, foreign influenced by government actions or inactions.
exchange, labour practices, occupational health and safety and
the environment also play a key role. Organisations such as the Vancouver-based Fraser Institute
The settings of any mineral policy, and its role in assisting the annually rank mining regions and nations on the attractiveness of
achievement of major economic and social goals, will depend their mineral policy and mineral endowment for exploration
significantly on the richness of a country’s, or region’s, mineral investment. In their 2004-05 survey of 1121 companies – Fraser
endowment. When the quality of mineral reserves is high, a Institute (2005) – they reviewed the attractiveness of 64
government may be more demanding in its dealings with jurisdictions. The coverage of their study and the relative
companies, whose potential profits will also be high. rankings of the Australian states appear in Table 13.3.
It is important also to appreciate the views of mining and While the rankings of the Australian states and the Northern
exploration companies. In a study for the United Nations, Otto Territory ranged between ten and 25 for mineral policy
(1992) conducted a survey of 39 large and small mining attractiveness, their overall mineral potential (which takes
companies to determine the importance of various investment account of the attractiveness of policy and geological
endowment) in the minds of company decision-makers was
criteria to them in the mineral exploration and mine development
higher, with three Australian jurisdictions – Western Australia,
phases. His findings are reproduced in Table 13.25. Of particular
the Northern Territory and Tasmania ranking in the top ten.
note is his assessment that 17 of the 22 factors (those marked in
bold typeface) on the list are ‘controlled or influenced by
government actions or inactions’. A nation’s mineral policy
THE TRANSITION OF MINERAL POLICY
settings clearly are important in assisting its competitiveness as a SINCE 1950
destination for new mineral sector investment. There have been several notable trends over the past 40 years in
the structure of the world mineral industry. In the immediate post
World War II period much of the mining of metals in the
4. See Otto (1997) on the importance of national mineral policies and
developing world stood in private hands. The public sector, was,
associated policy documents.
however, responsible for all mining in the socialist world and
5. This table is taken directly from Otto (in press). Other studies have there were significant public ownership positions in the mineral
generated similar rankings of factors. industries of several European nations. Many coal mines in

156 Australian Mineral Economics

 CHAPTER 13: MINERAL POLICY — AN INTRODUCTION

TABLE 13.3 Governments in developing nations became major mineral

The relative attractiveness of mineral policy and mineral potential. producers during the 1960s and 1970s. By the early 1980s
(Source: Fraser Institute, 2005.) state-owned mineral producers accounted for one third of overall
capacity in the developing world. According to Radetzki (1990),
Jurisdictions this was an increase from 2.5 per cent in the 1960s.
Area Jurisdictions Descriptions Mines and mineral processing facilities became part of a
Canada 12 Twelve provinces and territories broader development arm of government. More importantly,
United States 14 Fourteen states
state-owned mining companies became principal sources of
revenue for development projects. Their activities often
Australia 7 Six states and the Northern subsidised other sectors but this often had unfortunate
Territory longer-term consequences for the resources sector.
Oceania 4 Indonesia, New Zealand, Papua In his study for Resources for the Future, Radetzki (1985)
New Guinea and the Philippines argued that, despite some initial dislocation following
Africa 9 Botswana, Burkina Faso, DR nationalisation, the performance of state-owned mining
Congo, Ghana, Mali, South Africa, companies would then improve. After ten or 15 years, while their
Tanzania, Zambia, Zimbabwe efficiency would be still slightly inferior to that in private
Latin America 8 Argentina, Bolivia, Brazil, Chile, companies, the benefits from state ownership to the entire
Ecuador, Mexico, Peru, Venezuela community would more than compensate for this. A simple view
Eurasia 10 China, Finland, India, Ireland, of the Radetzki vision appears in Figure 13.3. One might argue
Kazakhstan, Mongolia, Russia, that the success of state owned mining enterprises such as
Spain, Sweden, Turkey Codelco in Chile, Outokumpu in Finland, MMC in Malaysia,
Total 64 LKAB in Sweden and Pechiney in France provides examples to
support this view.
Rankings of Australian regions Yet because of falling mineral prices, poor management and
State or Territory Policy potential Mineral potential
underinvestment, state operation of mineral enterprises was
unsuccessful in many nations with large mineral endowments.
New South Wales 19 13 This appears to have been particularly the case in nations such as
Northern Territory 25 8 Zambia, Bolivia, Jamaica, Peru and Papua New Guinea. The
Queensland 18 11 ‘Caribbean model’ outlined by Auty (1993) seems more in line
with these experiences (see Figure 13.4). Despite large mineral
South Australia 15 18 endowments, the economic performance of these nations has
Tasmania 10 6 been disappointing.
Victoria 23 23
Efficiency
Western Australia 12 4

countries such as Britain and Australia were also publicly owned.

The motivations for such ownership, as Radetzki (1990, pp 132 -
133) notes, arose from factors such as:
• ‘the widespread perception of mineral wealth as a national
patrimony’;
• the relative ease of exploiting mineral resources because of
the immobility of deposits;
• the existence of high rents, which would have been more Pre Post nationalisation
difficult to appropriate using the fiscal system (taxes, royalties
etc) where they were privately owned or operated; and
• the perceived strategic importance of a national mineral industry. Time
The post-1960 surge in public ownership FIG 13.3 - State ownership and mining company efficiency –
the Radetzki view.
During the 1960s and 1970s there was a movement towards
widespread public ownership of mineral production, Efficiency
particularly among newly independent nations. The logic behind
this was that it enhanced political independence and that it would
facilitate development. The success of OPEC in raising prices of
oil in 1973 and 1979, as well as the sense of impending scarcity
created by the Limits to Growth thesis strengthened the appeal of
resource nationalism in many countries during the 1970s. This
was even apparent to some extent in Australia during the years of
the Whitlam Federal Labor government.
These sentiments were accompanied, during the cold war, by
the perceived need to secure supply of strategic minerals and the
establishment of significant strategic stockpiles. Pre Post nationalisation
The modes and extent of resource nationalism varied from
country to country. In some it included restricted foreign
ownership, as well as restraints on dividend remittance and profit Time
repatriation. In others there was a complete government takeover
of mines. Some governments took direct equity ‘free carry’ FIG 13.4 - State ownership and mining company efficiency –
positions in mines and mining companies. the Auty ‘Caribbean model’.

Australian Mineral Economics 157

CHAPTER 13: MINERAL POLICY — AN INTRODUCTION
Furthermore political instability, sovereign risk and the fear of
nationalisation by foreign companies resulted in major
disinvestment from new African nations particularly but more
generally from other developing nations. Changes in ownership
rules and regulations on dividend and profit remittances
additionally created an unstable investment climate particularly
during the 1970s.
During this period, established mineral producers such as
Australia, the United States, Canada and South Africa were
favoured strongly by established mining and exploration
companies. While they received 60 per cent of world mineral
exploration spending in the 1960s, this had risen to 80 per cent
two decades later.
Africa’s mineral production capacity gradually declined as a
result of under-investment in the sector and because of the lack
of technical and human capacity in independent nations. Mineral
sector reinvestment fell, as profits from the sector became a
source of revenue for other development objectives. Major
technical problems emerged at most state-owned mines and this
adversely affected production. Important support services such as
the collection of basic geological information also were
adversely affected as decision-makers transferred resources from
profitable mining companies to boost agriculture and newly
emerging manufacturing industry.
The swing back to private ownership
Beginning in the mid-1980s a counter trend back towards
privatisation of mineral development and production began
emerging in many nations. Policymakers recognised that only
new foreign investment would enable the orderly development of
their mineral sectors. The demise of communism in the Soviet
Union and Eastern Europe strengthened this view and many
nations moved to revise their national mineral policies.
Otto (1997) notes that, in the ten years after 1985, almost a
hundred nations introduced or began serious work on revising
their mineral related legislation. This resulted in the publication
of many revised national mineral policies, which reduced or
completely removed any discrimination applying to foreign
investment. The process has continued since the mid-1990s.
As a result of this change, there has been growing foreign
investment in mineral exploration and mining ventures in Africa,
Latin America, Asia and Oceania. Australian and Canadian
mining companies have been prominent in this development.
Maponga and Maxwell (2000) observed for example that by the
mid-1990s, Australian mining companies had interests in more
than eighty nations. Canadian mining investment seems to have
been even more widespread. By 1998, the 80/20 split of
exploration spending between the established mining nations
(Canada, the United States, Australia and South Africa) and the
rest of the world had changed to an estimated 37/63 split.
Part of this dramatic change has been associated with a range
of policy forces in developed nations, which have discouraged
the development of the mining sector. In describing a ‘Global
Policy Revolution that is Affecting Access to Minerals’ Otto (in
press) points to issues in developed nations such as changed land
use priorities, reduced security of tenure, nimbyism, native title
legislation, permitting delays and exploration maturity as
negatively affecting mineral extraction activity.
Other important factors in the evolution of mineral exploration
and development during this period have been the liberalisation
of financial markets and the easy availability of equity funds
through stock exchanges particularly in Australia, USA, Canada
as well as the demonetarisation of gold.
In the wake of these policy changes, large companies strongly
expanded their influence. Operations in different sectors of the
mineral industry have become much more concentrated. As
noted in Chapter 7 above, many sectors of the industry are now
158
dominated by a small number of large transnational mining
companies (oligopolies). Their market power is counteracted in
several places by oligopsony (a small number of influential
buyers of mineral output for downstream production).
Some current policy realities
Relationships between large mining companies and the nations
that host their investments have now become important in
economic and social terms. Andrews (1998) points out, for
example, that the size of mining transnationals often compares
favourably with the size of the economies of the small nations in
which they operate.
Consider the cases of BHP Billiton and Rio Tinto. In 2004, the
reported turnover of BHP Billiton amounted to almost US$ 18.3
billion, while that of Rio Tinto was US$ 11.8 billion. Both had
operations in 13 nations. BHP Billiton was arguably larger in
economic size than three of the countries in which it operated –
Surinam, Mozambique and Bolivia. Rio Tinto may be larger
economically than Papua New Guinea and Namibia, the two
smallest nations where it has operating mines.
Such companies provide a major source of government
revenue through their payment of taxes and royalties and they
make major contributions to the development of remote regions.
BHP Billiton and Rio have been particularly influential in places
such as the Pilbara. The interaction between mining companies,
national and regional governments and local communities is
important.
Particularly in developing nations, but also in developed
nations, central or provincial governments may be unable or have
no interest in providing suitable infrastructure facilities to the
local communities close to the area of mining operations. In such
case companies must sometimes act as a surrogate government in
the local communities in which they operate. This may involve
the provision of roads, housing, schools, health services,
electricity and other community infrastructure. In some cases (eg
Porgera in Papua New Guinea), national governments may be
willing to reduced taxation if the mining company builds and
maintains local infrastructure. The effective management of
relations with local communities is a key factor in determining
whether a mining operation is successful or not.
In the current world of competition for foreign investment,
mineral policies must be framed in a competitive way by host
governments. Yet all of the stakeholders must be satisfied if
mining is to be a success. This includes company shareholders,
local communities, workforces, indigenous populations, financial
backers, regional and national governments. It is and will
continue to be a major task to manage these interactions
effectively. Good mineral policy has an important role to play in
facilitating this outcome.
Towards a competitive regulatory and fiscal
regime for exploration and mining
So, how does government translate all this in practice? The task
is difficult because, as already mentioned, different levels of
government, ie federal, state and local, as well as other
stakeholders with a legal or perceived power of veto, lay separate
claims to parts of the mineral rent. As a consequence there are
few, if any, government policy documents that clearly state and
quantify the desired level of aggregate government revenue.
There is however significant evidence of the types of
regulatory and fiscal regimes that have generated strong mineral
exploration and large mining sectors in their countries. All of
them seem to have certain common characteristics.
A pre-requisite to success is that a nation or region should
generate a perception of high geological prospectivity. A
perception of prospectivity is distinct from an actual mineral
Australian Mineral Economics

resources endowment, although evidence of previous mineral
discoveries and an abundance of successfully operating mines
provides an encouraging base. Government can however,
enhance the perception of prospectivity in the eyes of potential
investors by facilitating effective collection and inexpensive
dissemination of regional geoscientific data and information as
well as the reports relating to previous exploration programs
carried out by private industry. Thus a fundamental policy
component is good strategic planning and resourcing of the
activities of the relevant Geological Survey organisations and
support of related research institutions.
Another critical policy aspect for industry is the presence of
sound, fair, and predictable legislation to regulate the awarding
and maintenance in good standing of exploration and mining
titles. Allocation of titles should be fair and non-discriminatory
(eg on a first-in-time basis). There should be clear provisions for
the transition from exploration to mining titles, giving the
discoverer a guaranteed right to develop and mine. Ideally the
mining legislation should not be capable of being subverted by
other laws or at least there should be in place clear protocols to
resolve any potential conflict. This may arise with respect to
rights of other land-users, community stakeholders including
land owners and indigenous communities and the state of the
environment.
The conditions under which a mine can be developed and
operated throughout its life should be clearly stated, understood
and agreed when the development is approved. These should
reflect community expectations for occupational health and
safety, and technical and environmental management of the
project, including stringent rules for progressive or final
rehabilitation of the mine site. The various regulatory roles of
government in this context should be well coordinated and
ideally there should be a ‘one-stop-shop.’ While legislation
should embody adequate penalties for breach of tenement
conditions, the philosophy of the regulatory institutions should
not be that of a policemen. Rather they should support and
encourage effective, outcome-focussed planning and
management by industry, with a progressive shift from policing
to an advisory and auditing role to ensure that appropriate
systems are put in place.
Fiscal arrangements should be competitive and stable. Given
the capital-intensity and up-front nature of mining investment
and the ‘captive’ nature of mining operations, industry values
fiscal stability more than just lower but uncertain tax rates. When
considering fiscal arrangements, one cannot value their
components in isolation. A more objective view will come from
analysing the ‘package’ of all government-levied imposts. As
discussed in detail in Chapter 15, these can be divided into:
• those fiscal measures that are in common with all other
tax-payers; and
• provisions which are specific to the mining industry.
The latter include mineral royalties, which in Australia are
typically levied by the states and a host of mining-specific
provisions embodied in the Australian income tax legislation,
primarily providing for immediate write off of exploration
expenditure and accelerated depreciation of some mining assets.
In terms of broader investment, policy provision for
repatriation of profits and dividends overseas, for unlimited
foreign equity in mining projects and the absence of mandatory
government equity participation have served Australia well in
attracting foreign investors.
Australian Mineral Economics
CHAPTER 13: MINERAL POLICY — AN INTRODUCTION
Interestingly, with globalisation and the opening of many
countries encouraging foreign investment in mineral exploration
and mining, there has seen a flurry of drafting of new mining acts
and regulations, or at least of revisions of the old ones. In this
process the legislation of traditional, successful mining countries
such as Australia and Canada as been used as a model. As a
result there has been a tendency for regulatory and fiscal
‘packages’ to become more similar.
The ultimate decision of whether to invest in a country may
increasingly depend on the degree to which the country’s
administrative reality reflects the invariably laudable intents of
its legislation. There is now emerging evidence that many
administrative structures are failing to effectively enforce what in
better-organised countries would be excellent legislation. In
many cases it will take many years for the relevant institutional
strengthening to take place and for the administrative systems to
work in an effective and efficient manner. This may be a
symptom of potentially a more serious inadequacy and instability
in the country’s general political and administrative capacity. If
so, it can bring greater sovereign risk and a significant
disincentive to invest in a nation in spite of it having all the right
attributes on paper.
REFERENCES
Andrews, C B, 1998. Emerging trends in mining industry partnerships,
Natural Resources Forum, 22(2):119-126.
Australian Bureau of Statistics, 2005. Year Book Australia 2005
(Australian Bureau of Statistics: Canberra) [online]. Available from:
<http://www.abs.gov.au>. Date accessed: 8 May 2006.
Auty, R M, 1993. Sustaining Development in Mineral Economies: The
Resource Curse Thesis (Routledge: London).
Fraser Institute, 2005. Annual survey of mining companies 2004/2005
(Fraser Institute: Vancouver) [online]. Available from: <http://www.
fraserinstitute.ca/shared/readmore.asp?sNav=pb&id=738>. Date
accessed: 8 May 2006.
Garnaut, R, 1995. Dilemmas of governance, in Proceedings Mining and
Mineral Resource Policy in Asia-Pacific: Prospects for the 21st
Century (eds: D Denoon, C Ballard, G Banks and P Hancock), pp
61-66 (Division of Pacific and Asian History, Australian National
University: Canberra).
Garnaut, R and Clunies Ross, A, 1983. Taxation of Mineral Rents
(Clarendon Press: Oxford).
Maponga, O and Maxwell, P, 2000. The internationalisation of the
Australian mineral industry in the 1990s, Resources Policy,
26(4):199-210.
Otto, J M, 1992. A global survey of mineral company investment
preferences, Mineral Investment Conditions in Selected Countries
of the Asia-Pacific Region, New York, United Nations ST/ESCAP/
1197:330-342.
Otto, J M, 1997. A national mineral policy as a regulatory tool, Resources
Policy, 23(1-2):1-8.
Otto, J M, in press. Competing for investment – Competitive position of
countries seeking exploration and development investment,
Economic Geology.
Radetzki, M, 1985. State Mineral Enterprises: An Investigation into
Their Impact on International Mineral Markets (Resources for the
Future: Washington DC).
Radetzki, M, 1990. A Guide to Primary Commodities in the World
Economy (Basil Blackwell: Oxford).
Randall, A, 1987. Resource Economics: An Economic Approach to
Natural Resource and Environmental Policy (Wiley: New York).
Tilton, J E, 2004. Determining the optimal tax on mining, Natural
Resources Forum, 28:144-149.
Waud, R N, Maxwell, P, Hocking, A, Bonnici, J and Ward, I, 1996.
Economics, third Australian edition (Longman: Melbourne).
159

The Legal and Regulatory Environment of Mining
Gavin Jahn
Introduction
The Australian Federation
Inconsistency Between State and Federal Laws
Commonwealth Power
State Legislation – The Western Australian Situation
Conclusion
Appendix – Validity and Consistency Under Section 109 of the Australian Constitution
INTRODUCTION
This chapter provides a brief overview of some of the more
important legal issues within the mining environment. More
specifically, the discussion takes into consideration how the
mining industry is directly and indirectly affected by the specific
powers of the Commonwealth of Australia and the residual
powers of the state of Western Australia. The situation in
Western Australia has parallels in the other Australian states.
It is not possible to cover all parts of the law in detail and not
all areas of the law are in fact detailed herein. However, the
writer considers that those topics covered are the major areas that
impact upon the industry.
The Australian legal system relies upon judge made law, also
known as common law, and statute law or laws made by
parliament. Laws pertaining to the mining industry fall largely
within the ambit of statute law. Statute law can be made by either
the Commonwealth Parliament or alternatively state parliament.
1. Prior to 1 January 1901, six British colonies.
2. Known popularly as the ‘Washminster system’.
3. The Constitution provides for a Westminster system of executive
government (with no strict separation of powers between the
legislature and executive) engrafted onto a United States system of
strict separation of the judicial power and a federal legislature of
House of Representatives and Senate.
4. The political theory attributed to Montesquieu is that the specific
powers are limiting and the strong power lies in the residue. The
Canadian model essentially gives specific powers to the provinces and
the residuary power to the federal government. Wide judicial
interpretations of some specific powers have rendered the theory otiose.
5. Inconsistency may be due to direct or indirect conflict where the
Commonwealth has expressly or impliedly expressed an intention to
‘cover the field’ (Clyde Engineering v Cowburn, 1926). Thus,
Commonwealth and state laws can be inconsistent even when both
laws say the same thing.
Australian Mineral Economics
CHAPTER 14
The Australian Constitution (Commonwealth of Australia, 1900)
effectively grants specific power to the Commonwealth to make
laws on certain areas. Topics not covered under the Australian
Constitution fall to the states known as the residual power. This
chapter examines some of the laws made by the Commonwealth
under the specific power granted under the Australian Constitution
and laws that fall to the state under the residual power.
THE AUSTRALIAN FEDERATION
Australia is a federation of six sovereign states1. The Australian
federal system of government is based partly on the Westminster
model and partly on the United States model2 and it also has
some unique Australian elements.
There are two aspects of the Australian Constitution in
particular that are important. These are:
1. the separation of powers between the legislature, executive
and the judiciary3; and
2. the division of powers between the Commonwealth
Parliament and the states.
This chapter deals with this aspect of Australian ‘federalism’,
which owes much to the United States model by conferring
specific powers on the Commonwealth with residual powers
residing in the states4.
The Australian Constitution confers some exclusive specific
powers on the Commonwealth (eg section 122 – power over the
Australian Capital Territory). Other specific powers are
conferred in section 51 jointly on both the Commonwealth
Parliament and on the states, but section 109 of the Constitution
provides that, in the event of conflict between the
Commonwealth and state laws, the Commonwealth law shall
prevail and the state law is invalid to the extent of the
inconsistency5. Further inroads into state residuary power have
occurred because of permitted application of the external affairs
power within Australia and by the wide interpretation of the
incidental scope of the Corporations power.
161
CHAPTER 14: THE LEGAL AND REGULATORY ENVIRONMENT OF MINING
The words in the Constitution may possess two meanings:
• That referrable to the main grant of power analogous to an
‘umbra’.
• That referrable to the incidental power analogous to a
‘penumbra’. Incidental powers may be either express or
implied. Section 51(xxxix) expressly confers legislative
power ‘with respect to…matters incidental to the execution
of any power vested by…Constitution in the Parliament…’6.
In addition, the High Court recognises a common law
incidental power impliedly ‘included in the grant of every
power and every control the denial of which render the grant
itself ineffective’ (D’Emden v Pedder, 1904).
Judicial interpretation of the Constitution can be characterised
by literalism or progressivism. Literalism has been the dominant
method, which reads words according to their natural sense and
in documentary context and then gives the words full effect
(Craven, 1992; Blackshield and Williams, 1998). Progressivism
applies judicial legislation to achieve economic and social
outcomes (Craven, 1992 p 23).
INCONSISTENCY BETWEEN STATE AND
FEDERAL LAWS
The Constitution provides a mechanism for resolving conflicts
between state and federal laws, the ultimate resolution being in
favour of the latter, much to the chagrin of the former.
Section 109 of the Constitution provides:
When a law of a State is inconsistent with a law
of the Commonwealth, the latter shall prevail
and the former shall to the extent of the
inconsistency be invalid.
This is not a rule of ultimate desperation but is a primary and
important explicit constitutional provision. If there is an
inconsistency, section 109 immediately renders state law
ineffective and neither the Commonwealth nor state Parliaments
can frustrate that automatic overreaching consequence.
Section 109 is about the interpretation of two sets of laws and
the interaction between those laws once they are interpreted.
Namely section 109 is not about:
• the constitutional limits of Commonwealth and state powers
enabling those laws; nor
• the mode of interaction between those powers.
The meaning of law
It is important to appreciate the meaning of the word ‘law’ for
the purposes of section 109.
• Clearly statute law is fundamental.
• Delegated legislation, ie regulations, ministerial orders and
industrial awards have also been included in the definition of
‘law for these purposes’7. All delegated legislation must be
read pursuant to the enabling Acts. Under the ultra vires
6. Confirmed by the High Court in Grannall v Marrickville Margarine
Pty Ltd (1955) 93 CLR 55 at 77. The cases indicate that the scope of
the incidental power is subjective depending on the judges.
7. Not so clearly in the case of industrial awards, which have an aura of
the quasi-judicial despite also being clearly legislative in the sense
that awards make rules to operate in futuro. Nevertheless, clearly
awards are ‘law’ pursuant to their enabling statutes.
8. Under this doctrine delegated legislation that exceeds or abuses the
power conferred by the enabling Acts is void.
9. The Uniform Companies Acts 1961, the companies (name of state)
codes of the 1980s known as the Cooperative Scheme.
162
Doctrine8 the delegated legislation may be either simply ultra
vires or it may be qualified in some way by the enabling
Acts. Section 109 is therefore otiose. Consequently only if
the delegated legislation is intra vires or unqualified will
section 109 be relevant.
• Is common law a ‘law’ for the purposes of section 109?
Federal common law would be replaced by state statute law
(Jackson v Gamble, 1983). Neither is there inconsistency
where a state lacks power to legislate over a federal matter
(eg the Commonwealth common law crime of defrauding the
Commonwealth). State common law is overridden by any
valid Commonwealth statute.
A valid law is assumed at both state and federal levels before
section 109 becomes effective. Section 109 is not effective if the
Commonwealth fabricates inconsistency by exceeding its
powers. This is also the situation if the state law exceeds its
powers. On the other hand s 109 is self-executing. For example
both the Commonwealth and News South Wales had enacted
racial discrimination laws. The High Court had then held that
while there was no direct conflict between the Commonwealth
and New South Wales laws, the Commonwealth law had
intended to cover the field and the New South Wales law was
therefore inconsistent (Viskauskas v Niland, 1983). Subsequently,
the Commonwealth Parliament had legislated to reverse
retrospectively that decision. The High Court then held that due
to the self-executing nature of s 109, once the court has found
that s 109 applied, the federal Parliament was constitutionally
impotent to legislate retrospectively to reverse that finding
(Wollongong University v Metwally, 1984).
Lane (1997, p 770) states that logically the court would firstly
examine the validity of the Commonwealth law and only if it
were valid would the court then apply Section 109. While this
logical sequence has at times been followed (eg Johnston v
Krakowski, 1965), it is less time-consuming to argue Section 109
first. If there is no inconsistency then the validity of the
Commonwealth law need not be examined for these purposes.
Issues concerning validity and consistency are further considered
in the Appendix at the end of this chapter.
COMMONWEALTH POWER
The corporations power
The corporations power is conferred by section 51(xx), which
states:
The Parliament shall…have power to make laws
with respect to … foreign corporations, and
trading or financial corporations, formed within
the limits of the Commonwealth.
The Commonwealth corporations power is limited. Firstly it is
limited to foreign corporations and to Australian ‘trading or
financial’ corporations (eg bare holding companies are not
included). Secondly the High Court has consistently adopted a
narrow interpretation of the main grant of the Corporations
power. In Huddart Parker and Co Ltd v Moorehead (1909) the
High Court held that the word ‘formed’ in Section 51(xx) meant
already formed (ie registered under state law). The High Court
also questioned whether mining and investment companies fell
within Section 51(xx). For the whole of the 20th century,
Corporations law was state law albeit with attempts to achieve
uniformity9. Due to differential state interpretations of the laws,
the Commonwealth moved unilaterally and enacted the
Corporations Act 1989 (Cth), the constitutional validity of which
was examined by the High Court in New South Wales v
Commonwealth (1990). In that case the High Court followed
Huddart Parker and invalidated key sections of the 1989 Act,
particularly those empowering the formation of companies.
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The Commonwealth was forced to negotiate with the states,
confining the 1989 Act to the Australian Capital Territory (ACT)
with the states enacting the ACT Act as ‘The Corporations (Name
of State) Law’ 1991 (called the Corporations Law Scheme).
Constitutional difficulties with federal authorities enforcing state
law made the Corporations Law Scheme unworkable.
In 2000 the states (and the Northern Territory) referred their
Corporations powers to the Commonwealth pursuant to
s 51(xxxvii) subject to state termination (Corporations Act 2001
(Cth) Part 1.1):
• Under a five year sunset clause.
• If the Commonwealth used the corporations power to enact
new industrial laws. The Corporations Law was re-enacted
with incidental changes as Commonwealth law in
Corporations Act 2001 (Cth), which undeniably covers
mining companies and continues to provide for ‘no liability’
mining companies where this form of corporate organisation
is desired to facilitate equity fundraising.
The Corporations Act 2001 (Cth) provides inter alia for:
• Registration of corporations.
• Fundraising by equity and debt securities. Primary trading in
securities to the retail market requires a disclosure document
(eg a prospectus) while private placements to the wholesale
market are exempt. On-market secondary trading requires
continuous disclosure under the ASX listing rules. Off-market
secondary trading generally does not require disclosure but
there are exceptions for the retail market (eg direct or indirect
sales by a controller to the retail market and secondary trading
to the retail market that is treated as primary trading may
require disclosure in stated circumstances).
• Corporate governance.
• Takeovers regulation.
• External administration (eg receivership, voluntary administration
and liquidation).
Industrial relations power
Effective Industrial Relations legal and regulatory systems assist
both employers and employees and significantly contribute to
economic stability. Australia has both federal and state industrial
relations systems10.
The Commonwealth ‘Industrial Relations’ power is conferred
by Section 51(xxxv) of the Constitution, which states that:
The Parliament shall … have power to make laws
… with respect to conciliation and arbitration for
10. Subject to some reservations, Victoria referred its industrial relations
power to the Commonwealth – Commonwealth Powers (Industrial
Relations) Act 1996 (Vic); Workplace Relations Act 1996 (Cth) Pt XV.
11. The Conciliation and Arbitration Act 1904 (Cth) was enacted
accordingly.
12. This must be a real and not merely a paper or sympathy dispute.
13. It is interesting to speculate the effects if the Premier’s threat is
carried out. Firstly the Corporations Act 2001 (Cth) will not ‘cover
the field’ with respect to Queensland, leaving that state free to enact
its own corporations (or similar) legislation. Secondly, quaere
whether new Commonwealth industrial laws based on the
Corporations power are capable of application in a state that is no
longer bound by Commonwealth Corporations laws?
14. This public interest test applied to other industrial applications and
provided that the workplace agreements would not be
disadvantageous when compared with relevant awards.
15. Pursuant to the Labour Relations Act 2002 (WA) which also
provided for a regulated phasing out of the individual agreements.
(See generally Wheelwright, 2003, p 249).
Australian Mineral Economics
the prevention and settlement of industrial
disputes extending beyond the limits of any one
state.
The Industrial Relations power is therefore limited. First, it is
limited to conciliation and arbitration11 and not collective
bargaining per se. Second, while ‘prevention’ enables early
intervention (eg a threatened, pending or probable dispute) the
major import is focused on ‘settlement’. Third, there must be an
‘industrial dispute’, which requirement promotes industrial
confrontation. Last, there must be an interstate dispute12. This
final requirement has led to vibrant state industrial systems in
most states to deal with intrastate disputes.
However, current Commonwealth Industrial law is based
largely on the Corporations power in section 51(xx). Despite the
consistently narrow interpretation given by the High Court to the
main grant of the Corporations power (Huddart Parker and Co
Ltd v Moorehead, 1909; New South Wales v Commonwealth,
1990) the High Court has, since Strickland v Rocla Concrete
Pipes Ltd (1971), given wide incidental interpretation to the
Corporations power so as to permit extensive Commonwealth
control over multifarious economic activities. The current
Workplace Relations Act 1996 (Cth) goes far beyond the scope of
section 51(xxxv) to cover industrial relations activities by
employer corporations. Further, the 1996 Act has:
• reduced the role of the Australian Industrial Relations
Commission by limiting the number of matters able to be
settled by award to 20;
• provided for Australian workplace agreements approved by
the employment advocate;
• allowed non-union certified agreements;
• empowered freedom of association; and
• reduced union roles in enterprise bargaining and industrial
matters overall (Wheelwright, 2003).
Media reports attendant upon the control of the Senate by the
federal Liberal-National Coalition as from 1 July 2005, have
speculated upon the stated intention of the Commonwealth
Government to enact new industrial laws based on the
Corporations power, which will expressly cover the field and
invalidate state industrial laws. The Premier of Queensland has
been reported as threatening to terminate (pursuant to
Corporations Act 2001 (Cth) Part 1.1) that state’s coverage by
the Corporations Law 2001 (Cth)13. The current High Court
appears to be conservative and legalistic. It is likely that the High
Court may restrict the recent wide incidental interpretations of
the Corporations Act 2001 (Cth) in the interests of preserving the
balance of Australian federalism.
The Western Australian industrial relations system has been
the subject of considerable recurrent changes resulting from
changes in state governments. Enterprise bargaining is effected
under the Industrial Relations Act 2002 (WA). A more
contentious approach through statutory individual workplace
agreements was provided for under the Workplace Agreements
Act 1993 (WA). These registered employer-employee agreements
were given paramountcy over relevant awards and were not
subject to the ‘no disadvantage test’14. However, the agreements
had to comply with the Minimum Conditions of Employment Act
1993 (WA).
Following the election of a Labor Government in 2001, the
Workplace Agreements Act 1993 (WA) was repealed15. However,
a form of employer-employee agreement is still available in
certain cases (see Industrial Relations Act 1979 (WA)).
Export power
This constitutional power of the Commonwealth over mining, in
particular uranium mining, is manifested in the control of exports
(section 51(i) of the Australian Constitution):
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The Parliament shall … have power to make laws
… with respect to: trade and commerce with
other countries, and among the states.
While the actual mining of particular ores in Western
Australia, including uranium, is covered under the Mining Act of
Western Australia 1978 the Commonwealth may refuse to grant a
licence to export the particular ore using its Constitutional power.
In particular, uranium may not be exported without a licence.
Australian customs (section 51 (ix) of the Australian
Constitution) will enforce the prohibition of exporting uranium
without a licence (Customs Act).
The Commonwealth’s power over exports is extremely
important because uranium is only mined in Australia for export.
Numerous mines have not commenced productions simply
because the Commonwealth refused to grant approval for the
exportation of uranium. This was particularly evident during the
currency of the so-called three mines policy under the Hawke
and Keating Labor governments.
In particular it should be noted that the Commonwealths role
in the uranium debate takes a very special position in respect to
the mining of uranium in the Northern Territory. Although
self-government was granted in 1978, the Commonwealth
retained control and ownership of uranium (Northern Territory
(Self Government) Act 1978 s 69(4)).
The power over exports is the foundation for the
Commonwealth role in appraisal of the environmental
implications of proposals to mine uranium. Environmental matters
are, however, not the only reason for Commonwealth interest in
mining of uranium. There are significant security reasons as well.
The Commonwealth Minister for Industry, Tourism and
Resources is responsible for administering export controls on
uranium pursuant to the Customs (Prohibited Exports)
Regulations 1958 (Schedule 9 of Regulation 11). Under the
‘three mines policy’ export permits for uranium were only issued
for uranium mined at ‘listed’ mines, namely Nabarlek, Ranger
and the Olympic Dam Operation.
The policy of the Liberal-National Party Government elected
in March 1996 is to approve mining and export of uranium from
any project which meets stringent environmental, heritage and
nuclear safeguards obligations. Uranium mining has become a
very topical discussion of late with the federal government
recently deciding to re-examine the financial benefits of
exporting uranium. It should however be noted that Australia is a
signatory to the Nuclear Non-Proliferation Treaty16.
External affairs power
The external affairs power is another power that the
Commonwealth utilised to influence its power over the states.
The Australian Constitution does not directly grant to the
Commonwealth any power to make laws with respect to ‘the
environment’:
The Parliament shall … have power to make laws
… with respect to: matters incidental to the
execution of any power vested by this Constitution
in the Parliaments or in either house thereof, or in
the Government of the Commonwealth, or in the
Federal Judicature, or in any department or officer
of the Commonwealth (Australian Constitution,
section 51(xxix)).
16. See the text of the Treaty online at: http://disarmament.un.org:8080/
wmd/npt/npttext.html. The treaty was entered into force in 1970 by
188 countries including Australia and reaffirmed in 2000. Among
other things, the Treaty was entered into inter alia to promote
cooperation in the peaceful uses of nuclear energy.
164
This a phrase of wide import covering not only treaties and
international conventions but also any kind of relations abroad.
There can be little doubt that under this external affairs power,
the Commonwealth does have substantial scope to make
environmental laws. After all, where a law can be characterised
with respect to a particular subject matter under section 51 of the
Constitution, it is irrelevant that the law may have environmental
purposes. The Commonwealth’s use of its legislative powers for
environmental purposes has not been without controversy, in
particular, its use of the external affairs power.
During the 1980s, the High Court, in a series of decisions in
particular Tasmanian dams (Commonwealth v State of Tasmania,
1983), brought a significant widening of the scope of the external
affairs power. It did this by allowing the Commonwealth
effectively to take control of vast tracts of land from states for the
purpose of implementing the terms of the Convention for the
Protection of World Cultural and Natural Heritage (World
Heritage Convention) within Australia.
In 1999 the Australian parliament passed the Environment
Protection and Biodiversity Act which is an attempt to provide
the Commonwealth with laws on the environment. To date, the
Commonwealth has not sought to take full responsibility for
environmental regulation in Australia. Yet, if Australia is to
remain true to the commitments it made as a participant at the
Rio conference, in particular, to enact ‘effective environmental
legislation’, it may be that at some time the Commonwealth will
be called upon again to use its legislative powers to override
environmental and developmental policies of individual states.
The purpose of this paper is to discuss the extent to which the
Commonwealth would be able to rely upon the external affairs
power to meet Australia’s commitments under the Rio
Declaration. First, there will be an examination of the framework
of international law and relations and of where the international
community’s interest in environmental protection as expressed in
the Rio Declaration (and Agenda 21) fits into it. Second, there is
a brief description of the evolution of international environmental
law. Third, High Court decisions on the external affairs power is
analysed and a conclusion drawn as to the extent to which the
Commonwealth may utilise the external affairs power for
environmental purposes.
In an era of globalisation one could argue that the external
affairs power has not yet been fully explored and that it is
becoming of great significance for the Commonwealth. However,
the impact of the external affairs power has been felt by the
mining industry through environmental protection legislation.
The cost of compliance has significantly increased and in
addition the focus of pure mining has been somewhat distracted
by having to consider the practicalities of compliance with the
likes of the Environment Protection and Biodiversity Act 1999.
In addition the Atomic Energy Act 1953 now requires the
Minister for Industry, Tourism and Resources to take account of
the requirements of the Environment Protection and Biodiversity
Conservation Act 1999 when dealing with project approvals or
issuing export permits.
Race power and native title
Of particular importance to mining within the states is the native
title issue and to a lesser extent racial discrimination. While
racial discrimination and native title may fall under the external
affairs power s 51 (xxix) of the Australian Constitution, the main
constitutional power for native title falls under s 51(xxvi):
The Parliament shall … have power to make laws
… with respect to: the people of any race, other
than the Aboriginal race in any state, for whom it
is deemed necessary to make special laws.
It should be noted that the words in bold were deleted from the
Constitution after a referendum was held in 1967.
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 CHAPTER 14: THE LEGAL AND REGULATORY ENVIRONMENT OF MINING
Native title legislation
Judicial recognition of native title at common law occurred in
Mabo v Queensland (1992) (No 2) (Mabo), a decision of the
High Court of Australia on 3 June 1992. Generally these native
title rights to land will be recognised where:
1. the claimants can establish that they have maintained a
continuous connection with the land in accordance with
their traditional laws and customs since British settlement
in 1788; and
2. the native title rights have not been lawfully extinguished.
After Mabo, considerable uncertainty existed about the validity
of proprietary rights in Australia, including rights in and to mining
tenements. To address those uncertainties, the Commonwealth
Parliament responded by passing the Native Title Act 1993 (Cth)
(‘NTA’). The Native Title Act came into operation in January 1994
and was substantially amended in 1998 in response to the decision
of the High Court in Wik v Queensland (1996). The Wik case
recognised that the granting of a pastoral lease did not necessarily
extinguish all native title rights, some of which could coexist with
the rights under a pastoral lease.
In Mabo, the High Court held that native title rights can be
lawfully extinguished by certain government legislation and
executive actions which are not inconsistent with native title. In
order for extinguishment to be lawful it must comply with the
obligations imposed by the Native Title Act.
In summary the Native Title Act:
1. provides for recognition and protection of native title;
2. sets up mechanisms for determining claims for native title
such as the ‘right to negotiate’ which allows native title
claimants to be consulted in relation to certain mining and
other developments;
3. makes valid certain ‘past acts’ which would otherwise be
invalidated because of native title;
4. establishes ways in which ‘future acts’ (for example the
granting of mining tenement applications and converting
exploration licences and prospecting licences to mining
leases) affecting native title may proceed and how native
title rights are protected, including rights to compensation;
and
5. provides a process by which claims for native title and
compensation can be determined.
The High Court decision of Ward v Western Australia
established that where tenure such as a pastoral lease is granted
on a mining tenement, native title is extinguished only to the
extent that it is inconsistent with the rights conferred by the
pastoral lease.
Native title claims
Persons claiming to hold native title may lodge an application for
determination of native title with the Federal Court. Once a
native title claim has been lodged, the court will refer the
application to the Native Title Registrar. The Native Title
Registrar must determine whether the claim meets certain
conditions concerning the merits of the claim, and certain
procedural and other requirements set out by the NTA.
If the Native Title Registrar is satisfied the lodged claim meets
the registration requirements set out in the Native Title Act
(‘Registration Test’) it will be entered on the Register of Native
Title Claims maintained by the National Native Title Tribunal
(‘Register’). Claimants under registered claims are afforded
certain procedural rights under the Native Title Act including the
‘right to negotiate’.
Australian Mineral Economics
Claims that fail to meet the registration test are recorded on the
Schedule of Applications Received. Such claims may be entered
on the register at a later date if additional information is provided
by the claimant that satisfies the registration test.
Validity of the tenements
1. Tenements granted prior to 1 January 1994 – the Native
Title Act permits a State to validate ‘past acts’. Western
Australia, New South Wales and Queensland all have
legislation that gives effect to this provision of the Native
Title Act. Mining tenements granted in Western Australia
prior to 1 January 1994 are deemed to be valid. To the
extent that the exercise of native title rights and interests is
inconsistent with the exercise of the rights conferred by
those tenements, the rights under each particular tenement
will have priority for the term of the relevant grant.
2. Tenements granted between 1 January 1994 and
23 December 1996 – these are known as ‘intermediate period
acts’. The 1998 amendments to the Native Title Act provided
scope for the states and territories to validate these acts.
3. Tenements granted since 23 December 1996 – mining
tenements granted since 23 December 1996 which affect
native title rights and interests will be valid provided that
the future Act procedures set out below were followed by
the relevant parties.
Assuming that all future Act procedures were followed, the
Tenements will be classified as valid future Acts under the NTA.
4. Future tenement grants – the valid grant of any tenement,
which may affect native title, requires full compliance with
the provisions of the Native Title Act in addition to
compliance with the usual procedures under the Mining
Act. The primary procedure prescribed under the Native
Title Act is the ‘right to negotiate’ process.
The right to negotiate process involves the publishing or
advertising of a notice of the proposed grant of a tenement
followed by a period of negotiation between the state
government, the tenement applicant and the relevant
registered native title claimant. If agreement is not reached
to enable the grant to occur, the matter may be referred to
arbitration before the National Native Title Tribunal, which
has a further six months to reach a decision. The decision
of the National Native Title Tribunal may be reviewed by
the relevant federal minister.
The right to negotiate process is not required to be followed
in respect of a proposed future act in instances where the
expedited procedure applies. Under the Native Title Act, a
future act is an act attracting the expedited procedure if:
1. the act will not interfere directly with the carrying on
of the community or social activities of the persons
who are the holders of native title in relation to the
land; and
2. the act is not likely to interfere with areas or sites of
particular significance, in accordance with their
traditions, to the persons who are holders of the native
title in relation to the land; and
3. the act is not likely to involve major disturbance to any
land or waters concerned or create rights whose exercise
is likely to involve major disturbance to any land.
When the proposed future act is considered to be one that
attracts the expedited procedure, the future act may be done
unless, within four months after the notification day, a native title
party lodges an objection with the National Native Title Tribunal
against the inclusion of a statement that the proposed future act is
an act attracting the expedited procedure.
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If there is no objection lodged within the four-month period,
the act may be done. If one or more native title parties object to
the statement, the National Native Title Tribunal must determine
whether the act is an act attracting the expedited procedure. If the
tribunal determines that it is, the minister may do the future act
(for example grant an exploration licence).
Further, the right to negotiate process does not have to be
pursued in cases where an Indigenous Land Use Agreement
(‘ILUA’) is negotiated with the relevant Aboriginal people and
registered with the National Native Title Tribunal. In such cases,
the procedures prescribed by the Indigenous Land Use
Agreement must be followed to obtain the valid grant of the
tenement. These procedures will vary depending on the terms of
the Indigenous Land Use Agreement.
STATE LEGISLATION – THE WESTERN
AUSTRALIAN SITUATION
Mining Act 1978 (Western Australia)
The Western Australian Mining Act 1904 adopted the philosophy
that land should be used for purpose for which it is most
valuable. It was also seen within the Mining Act that no person
should be entitled to hold any mineral right without being
prepared to work that land. The Mining Act applied
predominantly to gold mining, which at that time was the only
real mineral of any value being mined. It was not until 1978 that
a new Mining Act (the Act) was introduced into Western
Australia to initiate laws that would cover the more modern or
sophisticated methods of mining.
Under the Western Australian Mining Act 1904 there were
some 39 different types of titles. The Mining Act 1978 provides
for seven mining tenements (section 8). Under the current Act
there are three major tenements, which include one production
tenement (Mining Lease) and two investigatory tenements
(Exploration Licence and Prospecting Licence). The other four
tenements include the General Purpose Licence, Miscellaneous
Licence, Retention Licence and the Special Prospecting Licence.
Mining tenements
Two of the new mining tenements introduced into the Act
included the following.
The mining lease (ML)
A mining lease (section 85 Mining Act 1978 (WA)) gives the
holder the exclusive right to find, extract and dispose of any
minerals on the land the subject of that mining lease. The
maximum area over which a mining lease may be granted must
not exceed ten square kilometres (section 73). A mining lease
remains in force for a period of 21 years (section 78) from the
date of grant, the holder has an option to renew for another 21
years on expiry and further renewals are possible. The mining
lease entitles the holder to all minerals except iron ore unless
ministerial approval is obtained (see Special Agreements infra).
The tenement holder must be aware of conditions imposed on the
title, which include expenditure (section 82 Mining Act and
regulation 31 of Mining Regulations), conditions imposed by the
minister (section 71 Mining Act), environmental conditions
(section 84), security (section 84A) and reporting requirements
(section 82(1)(e) and regulation 32).
17. Mining Act 1978 grant of prospecting licence s 40(1), grant of
exploration licence 59(6), grant of mining lease 75(6).
18. Section 111 of the Mining Act specifically states that iron ore is
excluded from mining tenements ss 48, 66, 70J and 85.
166
The exploration licence (EL)
An exploration licence (section 66 Mining Act) remains in force
for five years from the date of grant (section 61(1)) with the
possibility of renewal by the minister in certain circumstances.
The holder of an exploration licence is required to expend certain
amounts (section 62 and regulation 21) upon exploration
activities during the term with failure to do so leading to possible
forfeiture of the licence.
The holder of an exploration licence has, subject to the Mining
Act, the right to apply for and to have granted a mining lease over
the land the subject of the exploration licence (section 67). The
exploration lease also has similar conditions to that of a mining
lease including security, environmental conditions and geological
record (sections 60, 63, 63AA and 68).
A further tenement recently introduced into the Act includes
the special prospecting licence (section 56(1)(1a)). The licence
can only be applied for 12 months after the grant of a prospecting
licence. A natural person can mark out a part (section 56A(6)(a)
– must not exceed ten hectares) of the prospecting licence as a
special prospecting licence for gold (section 56A(6)(b)). The
minimum term is three months with a four year maximum
(section 56A(6aa)).
Renewals and extensions of tenements
As with the granting of mining tenements, renewals and
extensions of mining tenements granted prior to 1 January 1994,
to the extent the renewals were invalid due to native title, have
been validated by legislation.
Renewals of mining tenements granted between 1 January 1994
and 23 December 1996 have been similarly validated provided
certain statutory criteria have been met.
Renewals made after 23 December 1996 of tenements validly
granted before that date will not be subject to the right to
negotiate process provided:
1. the area to which the earlier right is made is not extended;
2. the term of the new right is not longer than the term of the
earlier right; and
3. the rights to be created are not greater than the rights
conferred by the earlier grant.
There is doubt about whether the right to negotiate process
applies to second and subsequent renewals but this matter is yet
to be determined by the courts.
Other than as stated above, renewals of mining tenements are
subject to the same right to negotiate process as is described
above.
Special agreement acts
Under the Act the tenement holder is granted a right to prospect,
explore or mine for minerals on the land17. If the minister
considers it in the public’s interest (section 111A of the Act) the
grant may be made to mine only those minerals stated in the
lease (section 110 of the Mining Act).
The Mining Act specifically excludes the holder of a mining
tenement from mining iron18. The State Government has
controlled the development of iron ore deposits in Western
Australia through the use of special agreement acts (eg Broken
Hill Proprietary Steel Industry Agreement Act, 1952).
Mine Safety and Inspection Act 1994
The Mine Safety and Inspection Act 1994 (WA) (the Act) was
drafted using legislation from other Australian states and more
particularly similar United Kingdom legislation as a model. The
main purpose of the Act is to promote and secure the safety and
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 CHAPTER 14: THE LEGAL AND REGULATORY ENVIRONMENT OF MINING
health of those working in mining operations (section 3(a) Mines
Safety and Inspection Act 1994) as well as to assist employers
and employees to identify and reduce hazards relating to mines,
mining operations, work systems and plant at mines (section 3(b)
Mines Safety and Inspection Act 1994). The Act also protects
employees, fosters relationships between those involved in
mining operations as well as providing a process for employees
to contribute to the Act’s administration19.
More importantly, the Act imposes a duty not only on the
employer but also the employee, self-employers persons,
managers of mines and certain designers manufactures and
suppliers. As the name of the Act suggests this piece of
legislation is designed to ensure that all parties take the necessary
precautions to ensure the safety of all parties20.
Section 9 of the Act provides a duty on the employer to
provide and maintain a working environment that is free of
hazards. However, the paragraphs within section 9 state that such
an obligation is limited to providing a safe working environment
‘as far as is practicable’ or in the alternate provide such training,
instruction or protective equipment to ensure the employee is
aware of the hazards of working within such an environment.
Mine Safety Inspectors are proactive in the enforcement of
section 9 of the Act and employers are aware of the severe
consequences of a breach of the provisions. It should also be
noted that non-employees on a mine site including subcontractors
and visitors are also covered under the Act. The general duty of
care is therefore imposed on the employer or mine owner to
ensure the safety of anybody on the site (section 12 of the Mine
Safety and Inspection Act 1994 (WA)).
The Act is quite broad in its application and is not just
limited to a duty owed by the employer. Section 10 of the Act
states that the employee is also responsible not only for his or
her own safety but the safety of fellow employees through his
or her acts or omissions. Such breaches by the employee could
result in a fine of up to $10 000 or $20 000 where a death or
serious injury results from the failure of the employee to act
with due care or follow instructions of the employer. Under
section 13 of the Act a mine manager21 has a duty to ensure that
both the mine and access to and from the mine is free of
hazards otherwise face similar penalties as those imposed on
the employee.
Also designers, manufactures, importers and suppliers do not
escape liability. They have a duty to ensure that their equipment,
actions or inactions and products do not expose those who use
such equipment or products are not exposed to and form of
hazard or danger.
19. Section 3(c) Mines Safety and Inspection Act 1994 states – to protect
employees against the risks associated with mines, mining
operations, work systems at mines, and plant and hazardous
substances at mines by eliminating those risks, or imposing effective
controls in order to minimise them. 3(d) to foster and facilitate
cooperation and consultation between employers and employees and
associations representing employers and employees, and to provide
for the participation of those persons and associations in the
formulation and implementation of safety and health standards and
optimum working practices. 3(e) to provide procedures for
employers and employees to contribute to the development and
formulation of safety legislation for mines and mining operations
and to consult regarding its administration.
20. BHP Billiton Direct Reduction Iron have been charged by the
Department of Industry and Resources under sections 9(1) and 9(8)
(Duties of Employee) of the Mines Safety and Inspection Act 1994 in
regard to explosions at the Port Hedland Boodarie Hot Briquette Iron
(HBI) plant.
21. Under section 4 of the Act means the registered manager for the
mine. Section 33 of the Act requires the manager of the mine to be
registered.
Australian Mineral Economics
Mine inspectors have the power to lay charges (section 21 of
the Act) under the Act and institute or bring proceedings (section
96 of the Act) against an offender. However the general
understanding of the Act is for all parties to work together to
provide a safe working environment for all those engaged in
mining activities. The Act is designed to ensure the continued
improvement and education of a safe work place environment for
all those involved in the industry. Failure to comply may result in
criminal prosecution.
Aboriginal Heritage Act 1972
The Aboriginal Heritage Act 1972 (WA) (WA Heritage Act) is
specifically applicable to all of the tenements granted by the
minister imposing a condition that the Act be observed. The WA
Heritage Act makes it an offence to alter or damage an
Aboriginal site or object on or under an Aboriginal site. An
Aboriginal site is defined to include any sacred, ritual or
ceremonial site that is of importance and special significance to
persons of Aboriginal descent.
There is no requirement or need for an Aboriginal site to be
registered in any public manner or, indeed, to be in any way
acknowledged as an Aboriginal site for it to qualify as an
Aboriginal site for the purposes of the WA Heritage Act.
The tenement holders must ensure that any interference with
such sites is in strict conformity with the provisions of the WA
Heritage Act.
CONCLUSION
This chapter has examined some of the major pieces of
legislation that affect the mining industry at both Commonwealth
and state level. While state legislation may grant tenements and
the right to mine, subject to payment of royalties, mine safety,
aboriginal heritage and special agreements the Commonwealth
may prevent the export of minerals, oil or gas by utilising the
specific powers granted to Commonwealth under the
Constitution. This specific power granted to the Commonwealth
assists in its ability to control the exporting of products from
Australia. More particularly the increasing expanse of the
external affairs power ensures that the Commonwealth’s grip on
the mining sector is expanding. Such powers of the
Commonwealth significantly reduce the power of the states to
control the use of their minerals that form the basis, particularly
in Western Australia, of economic prosperity and benefit to the
people of that state.
REFERENCES
Amalgamated Society of Engineers v Adelaide Steamship Co Ltd, 1920.
28 CLR 129 at 150.
Blackshield, T and Williams, G, 1998. Australian Constitutional Law and
Theory, p 245 (Federation Press: Sydney).
Clyde Engineering Co Ltd v Cowburn, 1926. 37 CLR 466.
Colvin v Bradley Bros, 1943. 68 CLR 151.
Commonwealth of Australia, 1900. The Australian constitution [online].
Available from: <http://www.aph.gov.au/senate/general/constitution>.
Date accessed: 8 May 2006.
Commonwealth v State of Tasmania, 1983. 158 CLR 1.
Craven, G, 1992. Australian Constitutional Perspectives (eds: H P Lee and
G Winterton), p 2 (Law Book Company: Sydney).
D’Emden v Pedder, 1904. 1 CLR 91 at 110.
Department for Disarmament Affairs, United Nations, 1970. Treaty on
the Non-Proliferation of Nuclear Weapons (NPT) [online]. Available
from: <http://disarmament2.un.org/wmd/npt/>. Date accessed: 8 May
2006.
Grannall v Marrickville Margarine Pty Ltd, 1955. 93 CLR 55 at 77.
Huddart Parker and Co Ltd v Moorehead, 1909. 8 CLR 330.
Jackson v Gamble, 1983. 1 VR 552.
167
CHAPTER 14: THE LEGAL AND REGULATORY ENVIRONMENT OF MINING
Johnston v Krakowski, 1965. 113 CLR 552.
Lane, P H, 1997. Lane’s Commentary on the Australian Constitution,
second edition (Law Book Company: Sydney).
Mabo v Queensland (No 2) (Mabo), 1992. 175 CLR 1.
Mabo v State of Queensland, 1988. 166 CLR 186.
McLean (Ex p) 1930. 43 CLR 472 at 483.
Mining Act (WA) 1978. (Western Australian Government Printer: Perth).
New South Wales v Commonwealth, 1990. 8 ACLC 120.
O’Sullivan v Noarlunga Meat Ltd (No 1), 1954. 92 CLR 565.
Strickland v Rocla Concrete Pipes Ltd, 1971. 124 CLR 468.
Viskauskas v Niland, 1983. 153 CLR 280.
Ward v Western Australia.
Wenn v AG (Vic) 1948. 77 CLR 84.
Wheelwright, K, 2003. Labour Law, second edition, p 15 (LexisNexis
Butterworths: Sydney).
Wik v Queensland, 1996. 187 CLR 1.
Williams v Hursey, 1959. 103 CLR 30.
Wollongong University v Metwally, 1984. 158 CLR 447.
FURTHER READING
Fisher, D E, 1987. Natural Resources Law in Australia: A Macro-Legal
System in Operation (Law Book Company: Sydney).
Forbes, J R S and Lang, A G, 1987. Australian Mining and Petroleum
Laws, second edition (Butterworths: Sydney).
Hanks, P, 1994. Australian Constitutional Law Materials and Commentary,
fifth edition (Butterworths: Sydney).
Hunt, M, 1997. Minerals and Petroleum Law (Butterworths: Sydney).
Hunt, M, 2001. Mining Law in Western Australia, third edition (The
Federation Press: Sydney).
Lee, H P and Winterton, G, 1992. Australian Constitutional Perspectives
(Law Book Company: Sydney).
APPENDIX – VALIDITY AND CONSISTENCY
UNDER SECTION 109 OF THE AUSTRALIAN
CONSTITUTION
Invalid
‘Invalid’ in section 109 does not mean absolutely void and
probably does not mean ‘invalid’ at all but merely ‘ineffective’. If
the Commonwealth law should cease to apply for any reason (eg
the Commonwealth law is repealed), then the state law would
take effect.
The Commonwealth legislation renders inconsistency irrelevant
by showing an intention to admit state law as either co-existing
with or subsidiary to Commonwealth law.
The tests for inconsistency
The possibility of inconsistency depends on there being
commonality of underlying subject matter. For example, there is
no inconsistency if the Commonwealth imposes taxes for
Commonwealth purposes and the states impose taxes for state
purposes (eg the States have power to impose income taxes).
The converse however does not necessarily apply. There need
not be inconsistency although there is underlying commonality.
For example, state and federal police may investigate the same
matter but for different purposes.
The tests applied by the courts to determine inconsistency are
not mutually exclusive but fall into different characterisations
with overlaps.
Repugnancy
Repugnancy involves a direct collision between state and federal
law. It is impossible to obey both laws. Obedience to the one is
disobedience to the other.
168
In Mabo (1988) Queensland law extinguished the traditional
land rights of certain Torres Strait Islanders without similarly
adversely affecting the land rights of other Queenslanders
generally. Commonwealth law prohibited discrimination on
racial grounds resulting in inconsistency and invalidation of the
Queensland law.
However there is no collision if it is possible to obey both
State and federal laws. In Clyde Engineering Co Ltd v Cowburn
(1926) the High Court accepted that it was possible for a worker
to earn part of his wages under federal 48 hour week laws and
the other part of his wages under State 44 hour week laws
(although inconsistency was found on other grounds). The
converse of course is not always true – there may still be
inconsistency even when both laws say the same thing (Clyde
Engineering Co Ltd v Cowburn, 1926).
The Commonwealth permits or confers: the state
prohibits or deprives
Commonwealth law may permit an action or confer an immunity
while the state prohibits the action or deprives the immunity. In
Colvin v Bradley Bros (1943) a federal award gave qualified
permission for the employment of females on milling machines
while a New South Wales law prohibited it. The High Court held
that the New South Wales law was inconsistent.
In Williams v Hursey (1959) two Tasmanian waterside workers
refused to pay a political levy supporting the Australian Labor
Party. Federal law permitted the levy but Tasmanian law prohibited
it. The High Court found the Tasmanian law to be inconsistent.
The nature of the Commonwealth permission is important. Is
this a positive express authority to do something irrespective of
state law (as in Colvin v Bradley Bros, 1943) or is this a bare
negative licence to do an act where that act is not otherwise
permitted? What is the content of the Commonwealth
permission? Federal law may expressly exclude state law which
may be effected by enacting words such as: ‘the provisions of
this [name of Act] shall apply to the exclusion of [name of state
Acts]’. Federal law may also implicitly exclude state law (as in
Williams v Hursey, 1959).
Conversely there is inconsistency where the state permits and
the Commonwealth prohibits or the state confers and the
Commonwealth deprives.
Covering the field test
The ‘covering the field test’ has been particularly welcomed by
the Commonwealth but despised by the states for its blatant
enhancement of Commonwealth power even to the point of
Commonwealth paramountcy. The test is imprecise, Lane (1997
p 413) stating that this ‘law for any purpose, not just for a section
109 purpose’ is a slippery exercise.
The first hint of such a test came in Amalgamated Society of
Engineers v Adelaide Steamship Co Ltd (1920) but it was not until
1926 that it was firmly stated by Isaacs J in Clyde Engineering Co
Ltd v Cowburn (1926). Its most definitive statement however was
delivered in 1930 by Dixon J in McLean (1930):
[inconsistency] depends upon the intention of the
paramount legislature to express by its enactment,
completely, exhaustively or exclusively, what shall
be the law governing the particular conduct or
matter to which its attention is directed … When a
federal law discloses such an intention, it is
inconsistent with it for a law of a state to govern
the same conduct or matter.
Lane (1997 p 413) cites two weaknesses with this test:
1. What constitutes the ‘field’ covered by federal law?
2. When is the federal ‘coverage’ effected completely, exhaustively
or exclusively?
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 CHAPTER 14: THE LEGAL AND REGULATORY ENVIRONMENT OF MINING
The field
The scope of the field depends on the characterisation of the
Commonwealth law; that is ‘what exactly is the Commonwealth
law about?’ This focuses on the legal meaning of the law and not
the pragmatics of the way in which the law operates.
Coverage
Exclusions
As noted above, federal law may either expressly or impliedly
show an intention to exclude state law, which incidentally
indicates the coverage of a field. Since the several tests are not
mutually exclusive, express and implied exclusion may be applied
in their own right or as components of the covering the field test.
The width and detail of Commonwealth law:
The width and detail cannot be restricted by Commonwealth
omission. There can be an inconsistency even where federal law
does not cover matters covered by state law. The Commonwealth
is considered to have tacitly adverted to the ‘whole’ relevant area
of law and to have declined to specifically legislate for part of
that whole without diminishing the width and detail of the
coverage of that ‘whole’.
22. O’Sullivan v Noarlunga Meat Ltd (No 1) (1954) 92 CLR 565,
affirmed by the Privy Council in (1956) 95 CLR 177.
Australian Mineral Economics
In Wenn v AG (Vic) (1948) both Commonwealth and state laws
gave employment preference to World War Two ex-servicemen.
The Commonwealth law dealt with ex-servicemen seeking
employment and reinstatement, while a Victorian Act dealt with
promotion within existing employment. The High Court, in
finding inconsistency, said that the federal law made:
elaborate provisions for the benefit of
ex-servicemen … [and] deals extensively with
many aspects of rehabilitation (Wenn v AG (Vic)
1948, p 103).
Width and detail was also discussed in Noarlunga Meat22. South
Australian law required state registration of slaughtermen while a
Commonwealth law dealing with export meat slaughtering
required Commonwealth registration of slaughtermen. The High
Court described the width and detail of the federal law as:
extremely elaborate and detailed … almost every
detail is prescribed (O’Sullivan v Noarlunga
Meat Ltd (No 1) 1954, pp 591-592).
The South Australian law was judged inconsistent, thus
permitting a Commonwealth-registered slaughterman to work in
a South Australian meat works without first obtaining South
Australian registration.
Virtually universally therefore, whenever the Commonwealth
legislates within its powers, state laws will be found to be
inconsistent and invalid to the extent of the inconsistency. To a
significant extent the several tests of inconsistency necessarily
predetermine that result.
169

Mineral Taxation and Royalties
Frank Harman and Pietro Guj
Introduction
Economic Rent
Relevant Constitutional Powers
Design Principles for the Taxation of Mineral Rents
Current Mineral Taxation Regimes in Australia
Evaluating Australian Mineral Taxation and Royalty Systems
Commonwealth Company Income Tax
Mineral Revenue Policies for the Future
INTRODUCTION
Minerals sector taxation
Along with other sectors of the economy, the minerals sector
(including oil and gas exploration and production) is exposed to
a variety of taxes and charges. These are levied by
Commonwealth, state and local governments. A common range
of taxes and charges is applied to all sectors of the economy,
though the details of state and local government taxes and
charges may differ from place to place.
There are significant differences between the taxation
treatment of the minerals sector and all other industry sectors in
three areas. These are:
• mineral royalties collected by the states and the Northern
Territory under a variety of statutory provisions and related
regulations;
• taxation collected by the Commonwealth under the Petroleum
Resource Rent Tax Assessment Act 1987, and the royalties
collected by the Commonwealth under the Petroleum
Submerged Lands Act 1967; and
• company income tax collected by the Commonwealth
Government under special provisions contained in division
40 of the Income Tax Act 1997.
These special aspects of the government imposts on the
minerals sector are the focus of this chapter.
Contents of this chapter
Building on the foundation discussion in earlier chapters, this
chapter begins with a detailed analysis of the concept of
economic rent as the basis for the mineral taxation and royalty
Australian Mineral Economics
CHAPTER 15
regimes in Australia. This demonstrates how economic rents
arise in the minerals sector in unique ways relative to other
sectors of the economy and it shows why economic rents in the
minerals sector are the object of special taxation regimes. This is
followed by a discussion about how governments, if they wish to
capture part of these rents, should have the constitutional powers
to do so through the ownership of mineral resources, and a legal
right to impose tax regimes on the minerals sector.
The next section argues that governments should use well-
established tax design principles to ensure that important social
objectives are achieved with the taxation of economic rents in the
minerals sector. These principles include:
• economic efficiency in the way in which minerals are extracted;
• fairness or equity in the way the tax burden is allocated;
• a low administrative burden in terms of the costs of
complying with and enforcing the tax system;
• transparency in the liability for taxation from mining activity;
and
• stability in the revenue flow to governments.
The chapter then moves to a discussion of the various mineral
taxation and royalty systems currently in place by the
governments of the states, the Northern Territory and the
Commonwealth, together with data on the economic significance
of minerals sector taxation for government finances. These
current systems are then reviewed in the light of the tax design
principles to assess the ability of the mineral sector taxation
systems to achieve social objectives.
The provisions of the Commonwealth company income tax
specifically formulated for the Australian mineral exploration
and mineral sectors are then explained and the chapter concludes
with a discussion of mineral taxation policies for the future.
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
A note on terminology
In the literature on the taxation of the minerals sector, the
discussion is frequently couched in terms of mineral royalties
rather than mineral taxes. The use of the term royalty goes back
to the time when monarchs claimed a right to the so-called royal
minerals of gold and silver. In its modern usage, royalty has
come to mean a payment in return for awarding a right of some
form. This has special meaning in the Australian context and, as
indicated below, there is a debate about whether the revenues
taken by the state governments from the mining industry
constitute a royalty (based on the states’ handing over the right to
extract minerals owned by the state) or a tax. For the purposes of
this chapter, royalties collected by state governments will be
considered as taxes, though reference will be made to mineral
taxation and royalty regimes.
Why are there special taxation and royalty
regimes for the minerals sector?
Australian governments give a number of reasons why the
minerals sector should be subjected to a special taxation and
royalty regime, in addition to the range of taxes normally
imposed on all business sectors in the economy. These relate to
the sector’s capital intensity, the depletion of non-renewable
resources, and the desirability to generate a return to the public
as the original owners of natural resources. For example, the
authors of Mineral Resources Tasmania (2004, p 11) state that:
Royalty is not a tax but a payment to the
community for the purchase of non-renewable
resources from the state.
At the most fundamental level, however, it is the existence of
economic rent (ie a return on investment exceeding a normal
rate of return that would be sufficient to attract investment into
the enterprise) in the minerals sector that provides the basis for
the imposition of additional taxing regimes. Economic rent also
arises in many other sectors with the theory having its genesis in
agricultural land.
Before undertaking an investment in the minerals sector, investors
must have a realistic expectation that their investment will provide
future returns commensurate with the magnitude of their investment
and the risk that they will bear. Over time, the minerals sector
generates variable profit levels and sometimes profits are at levels
higher than the level of profit (normal profit) necessary to attract
and retain shareholders’ funds in the industry. This surplus
(economic rent) over the minimum profit level required by
shareholders represents the revenue on which government can, in
principle, levy taxation without discouraging investment.
Naturally, a finite mineral resource may generate ‘economic
rent’ only over part of the mine life, with subnormal profits
occurring when commodity prices are low. In theory the true
level of profitability could only be assessed after the deposit has
been exhausted, following recovery of the initial investment and
achievement of ‘normal’ rate of return.
Now let us reflect on whether mining activity should be taxed
because it involves the depletion of non-renewable resources.
Consider the case of a mine that, before any special tax regime
(but with the same taxes as paid by every other economic
activity), was producing a mineral with an average cost of
production (including normal profit and common taxes) equal to
its average revenue.
If government imposes an additional tax on the basis that the
mine operators are exploiting a non-renewable resource, then
costs of production will exceed revenue. The mine will close. In
the absence of some other compelling reason to close the mine
(for example environmental degradation), the imposition of a tax
results, in this case, in a loss of immediate mineral revenue to the
community.
172
This argument, however, may be simplistic in that progressive
lowering of extraction costs will ensure that projects get
developed in sequence as a function of their profitability, which
takes account of the prevailing taxation regime. Taxation of
non-renewable resources ensures the consideration of
intergenerational issues in the social taxation equation. The
question of an determining appropriate taxation rates, to achieve
a desired level of intergenerational equity, is a matter for society
to decide through the political process.
ECONOMIC RENT
Economic rent and normal profit
It is important to be absolutely clear about the meaning of
economic rent and normal profit.
Economic rent is the surplus revenue over and above costs of
production, where costs of production are counted as including
the appropriate level of normal profit.
Normal profit is the financial return to investors necessary to
attract and maintain their investment in a business activity. It is
determined by the return on alternative activities with the same
risk profile. In other words, it is the minimum rate of return to
investors that is acceptable, given other comparable investment
opportunities. Normal profit is an important concept in economic
theory, and it is sometimes described by other terms, such as the
opportunity cost of capital and the threshold rate of return.
Considering normal profit as a cost of production differs from
the accounting treatment of profit, which sees it as an overall
surplus after costs – including interest expenses, but not normal
profit – have been recovered. The accounting framework does
not distinguish between normal profit and economic rent and it
groups the equity return component of normal profit and
economic rent together as accounting profit. Accounting profit
(subject to some differences over the tax and accounting
treatment of a number of expenses such as depreciation) is the
measure of profit that forms the base for the imposition of
company income tax by the Commonwealth Government as
discussed later in the chapter.
Normal profit as a cost of production is a notion that is
sometimes difficult to comprehend. An intuitive understanding
can be grasped by looking instead at wages. What does an
employer have to pay workers to attract and hold them in the
business? The answer is at least what they could get in wages
from another employer, that is, their opportunity cost and wages
are clearly a cost of production.
If entrepreneurial activity were separated from the ownership
of capital, a comparable question would be: What rate of return
do entrepreneurs have to pay the owners of capital to attract and
hold capital in their business? The answer is at least the rate of
return that the owners of capital could get from another
entrepreneur with the same risk characteristics. This is the
opportunity cost of capital (normal profit) and is comparable
with wages as a cost of production. Consider the consequences if
an entrepreneur did not continue to pay the opportunity cost of
labour and capital. The owners of labour and capital would
transfer their labour and capital to other businesses and the
business would close. Paying both capital and labour their
opportunity cost is clearly a cost of keeping the business running.
Regulatory decision-making agencies such as the Australian
Competition and Consumer Commission (ACCC) use the
concept of normal profit widely. They typically refer to normal
profit as the weighted average cost of capital (WACC). The
concept of normal profit is also used in economic evaluation
techniques such as net present value (NPV) and economic value
added (EVA).
The origin of the term rent is in the application of the concept
of surplus to the earnings of landlords. With land in limited
supply, landowners could extract any surplus over costs of
Australian Mineral Economics

production from tenant farmers (where their cost of production
would include the opportunity cost of the tenant farmers’ own
labour) through the rent they charged. More fertile land would
yield higher rents than less fertile land.
Where land was of such limited fertility that the cost of
producing crops to the tenant farmer (excluding rent to the
landlord) was equal to the revenue from their sale, there could be
no rent for the landowner. This is the marginal farm, and this
concept, recast as the marginal mine, has an important
application in the design of mineral taxation systems.
In the modern minerals sector, the application of the concept
of rent is the same. The owner of mineral resources has the
ability to acquire economic rents either by undertaking mining
activity directly, or through the terms and conditions imposed on
any proposed mineral extraction by another party. Where the
government is the owner of the resource, it has the same
capability of extracting rents as any private owner. In recent
times, however, governments have generally been reluctant to
engage in mining activity directly and they rely on extracting
rents through taxation systems imposed on private sector mining
activities.
Economic rent and scarcity
In general, economic rent is the result of scarcity due to the
following factors:
• changes in supply and demand for a product;
• the deliberate actions of governments or businesses to restrict
supply and hence generate higher prices;
• the introduction of new technologies or products; and
• the parsimony of nature (high-grade ores are not as common
as low-grade ores and all ores are in limited supply).
All of these factors give rise to either higher prices or lower
costs, or both, and so are able to generate a surplus over costs of
production. It is important to note that economic rent does not
determine price, but rather that price determines economic rent.
Economic rents are not restricted to the minerals sector, but the
minerals sector classically generates and can maintain economic
rents because of some of its unique characteristics. These
include:
• Volatility in both the demand and supply of mineral products,
leading to large fluctuations in mineral prices independent of
costs of supply.
• Differences in the quality of mineral resources, where
differences in the quality (grades) result in differences in the
cost of producing a standardised unit of product – with the
same market price for the product, low-cost producers will
achieve higher surpluses over costs of production including
normal profits.
• The high entry costs in the industry creates the natural
conditions for the formation of cartels which then can
operate successfully in a way that generates a higher price
than the competitive market price. The OPEC cartel is the
obvious example. As the cartel manages supply it increases
price for all producers, the surplus is enhanced.
Politicians and political commentators describe the rents that
result from these factors as excess profits or windfall profits, but
‘economic rent’ is the preferred analytical and policy-relevant
term.
1. The original Hotelling analysis was not widely appreciated until the
oil crisis of the 1970s (see Solow, 1974).
2. The concept of differential rent is associated with the 19th century
economist David Ricardo and differential rents are also referred to as
Ricardian rents.
Australian Mineral Economics
CHAPTER 15: MINERAL TAXATION AND ROYALTIES
Economic rent, scarcity and the minerals sector
It is possible to refine further the concept of economic rent in the
minerals sector by considering the several sources of scarcity that
give rise to economic rents.
Firstly, there is the idea of generalised scarcity that arises
because a product is in short supply relative to its demand. This
generalised scarcity can be either a short-run or long-run
phenomenon depending on whether, in the long run, increased
supply can alleviate a short term scarcity.
• In the minerals sector an increase in demand for a particular
product, without an increase in supply, will give rise to
economic rents in the short term as a result of price increases
that flow from the scarcity induced by the increase in
demand. This is common in the minerals sector as its capital
intensive nature creates long lead times in the development
of new sources of supply. The substantial investment
required to develop new operations further adds to the
reluctance of businesses to increase production rapidly.
• In the longer term, these demand and price increases should
encourage an increase in the supply and a reduction in, or
even an elimination of, the economic rents as long as
previously untapped mineral resources are available at a
competitive cost of production.
• If new resources are not available, prices can increase
alarmingly, creating surging rents because of the increasing
scarcity as the currently exploited reserves are depleted.
• At some point, the rising prices may make substitutes
worthwhile, and the depletion process will then stop with the
switch to the substitutes.
This analysis of generalised scarcity for the mineral sector is
associated with the work of Hotelling (1931)1.
Secondly, there is the situation where mineral resources are
available for exploitation, but they differ in quality, some high
grade and others low grade. The owners of high-grade resources
will receive differential rents. They arise because high quality
resources have a lower cost of extraction and yet the uniform
final product sells for the same price regardless of the original
quality of the resource. At the limit, there is the marginal mine
that earns no rent2.
If there is a fall in final product prices, low-grade resources may
lose their economic rent and become marginal, but the operations
based on high-grade resources will continue to earn economic
rent. What was previously the marginal mine now becomes
sub-marginal and no longer earns sufficient revenue to pay all
costs of production, including normal profit, and will close down.
Figure 15.1 illustrates the relationships between generalised
rents, differential rents and the no rent case for a given market
price.
High-grade Low-grade Marginal
mine mine mine
(zero rent)
Generalised Generalised
rent rent
Differential
rent Cost of Cost of
Price
production production
Cost of
production
FIG 15.1 - Generalised rents, differential rents and zero rents for
different mines.
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
Thirdly, there is the possibility of a location rent. This is an
extension of the previous case of differential rent:
• two mining operations may have the same quality resource,
and the same extraction technology applied equally
efficiently to the resource, and sell at the same price in the
market;
• if, however, one is closer to the point of sale of the final
product than the other, its total costs, including transport
costs, will be lower, resulting in a location rent.
Finally, there is the case of monopoly rents where producers
artificially induce scarcity by restricting supply and increasing
the price, hence increasing the economic rent:
• the classic way this has occurred in the minerals sector is
through cartel-type arrangements where a number of
producers (and all producers if the cartel can organise it)
agree to accept reductions in production through the use of
quotas;
• the consequent contrived scarcity may be sustained as long
as the producers in the cartel stick to their quotas, and the
higher prices do not encourage non-members or new entrants
to expand output;
• generally, cartel activities are illegal and they do suffer from
cheating by members and increased production by
non-members.
Pursuing economic rent
Given the existence of sustained economic rents in the minerals
sector, it is not surprising that governments wish to share in the
rents. The preferred method to do this is through the taxation
system. As will be seen below there are other methods available,
although these are less satisfactory from an economic
perspective. In addition, other participants in the minerals sector
also try to gain access to economic rents. For example,
employees will seek higher levels of wages for their labour, and
suppliers of other inputs into mining operations will attempt to
increase their prices. The development of native land title rights
in Australia is also seeing rents flowing towards Aboriginal
people, sometimes quite explicitly as a royalty. Similarly, the
transfer of mineral rights between businesses will sometimes
include provisions that indirectly relate to the economic rent of
the deposit.
Pursuing economic rents that initially accrue to mining
companies is possible because economic rents are a surplus,
rather than a cost of production. Theoretically, then, the
extraction of economic rents through taxation or higher input
prices should not change the optimal level of production activity
of the mining operation because costs of production, including
normal profit, will still be covered. This theoretical outcome is
based on rent-seekers being able to extract the economic rent
without reducing the ‘normal profit’ flowing to the company.
Naturally the mining companies would prefer to keep the rents
for themselves.
For governments, the source of economic rent is captive in the
sense that, once mineralisation has been discovered or a mine has
been established, its locality cannot be changed. This contrasts
with manufacturing, which can physically relocate to a region
with lower taxes. However, a heavy rent taxing regime relative to
the tax regime in other states or countries with comparable
geological prospectivity and mining opportunities can discourage
investment in mineral exploration.
3. A company income tax could be an efficient tax on economic rents if
it had the design principles of the Brown tax (see Garnaut and
Clunies-Ross, 1983).
174
That all participants in the economy pursue economic rent is a
central focus of economic analysis generally, not just in the
mineral sector. The difference is that, in the wider economy, such
rents are usually only short term in nature. Economists call these
rents quasi-rents and they generally appear because of:
• changes in consumer tastes,
• new products, and
• new methods of production.
Quasi-rents will disappear in the short or long term where
there is no constraint on the long-term supply of goods and
services, and no restriction on entry by new companies into the
rent earning sectors and depending on how quickly economic
resources can be moved to overcome scarcity.
This is because owners of land, labour and capital currently
invested in a sector that does not have any economic rents – only
normal profit – will shift their resources into the rent-producing
sector in an attempt to capture rents. The existence of economic
rents thus acts as an important signal about how resources should
be allocated between sectors of the economy, and the pursuit of
these rents brings about a desirable reallocation of economic
resources in an economy.
As a general principle it is not appropriate for governments to
tax quasi-rents. To do so stifles the economic resource
reallocation process that these quasi-rents induce and leads to a
lower level of social wellbeing as a result of the failure to bring
about a reallocation of economic resources in accordance with
the demands of consumers.
The foregoing analysis, however, is predicated on the
assumption of a perfectly elastic supply of mineral resources and
the free movement of labour and capital in the long run. In the
minerals sector these conditions do not apply. Hence the
argument for government accessing mineral sector rents (or at
least a proportion of them) differs from any argument about
accessing all economic rents, including quasi-rents.
It is important to acknowledge that it is not necessary to devise
a special taxation regime to collect economic rents. The
company income tax has a tax base that includes both the return
to the equity component of normal profit and any economic rent.
This tax collects some economic rents. The company income tax,
however, is primarily designed as a tax on the income accruing to
the owners of capital in all corporate sectors of the economy. It is
not designed as an efficient tax on economic rents in the minerals
sector3.
RELEVANT CONSTITUTIONAL POWERS
Ownership and control of mineral resources
The Australian Constitution confers on the Commonwealth
Government specific powers in areas such as defence, customs and
excise, and monetary and fiscal management. Where the
Constitution is silent, however, relevant powers rest with the states.
As a consequence, the states have ownership and control of
mineral and petroleum resources within their jurisdiction.
The Northern Territory is not in the same constitutional
position as the states as it is a territory that derives its powers
from the Commonwealth Government under the Northern
Territory (Self-Government) Act 1978. Although the Territory has
extended powers of self-government, major powers retained by
the Commonwealth include rights in respect of Aboriginal land,
the mining of uranium and industrial relations.
The Seas and Submerged Lands Act 1973 declared
Commonwealth Government ownership of mineral resources as
extending to the high water mark of the seas adjoining the states.
The High Court upheld the constitutional validity of this
legislation in 1975.
Australian Mineral Economics

There is, however, an agreement between the Commonwealth
and the states, the offshore constitutional settlement (OCS),
(concluded at the premiers’ conference in 1979), which provides
the basis for an agreed division of powers between the
Commonwealth and the states in relation to coastal waters and in
relation to, amongst other matters, the regulation of offshore
petroleum exploration. The Commonwealth assumed ownership,
legislative powers over, and management of, offshore petroleum
resources including natural gas, subject to a number of
compensatory measures and royalty-sharing provisions with the
states. Included in these powers was that of setting and collecting
mineral and petroleum royalties.
Under the settlement the Commonwealth has given some de
facto sovereignty to the states by recognising both a baseline that
determines the extent to which any waters are under state
jurisdiction, and the concept of a territorial sea extending three
nautical miles (5.6 km) out from a baseline4. This gives the states
control over mining activities on the landward side of the
territorial sea border, including the right to impose tax and
royalty regimes.
In the offshore areas under exclusive Commonwealth
jurisdiction, states, under the OCS, have an administrative role
(as designated authorities) determining mineral extraction
activities and there is a sharing of some of the revenues collected
by the Commonwealth. These arrangements currently only apply
to the oil and gas industry.
It was only in the late 19th century that the Australian colonies
adopted the principle of Crown ownership of sub surface mineral
rights (effectively state government ownership) (O’Hare, 1971).
Prior to this time, owners of freehold title (land alienated from
the Crown) had rights both to the surface and to subsurface
minerals. The number of cases in this situation still prevailing is
small and in some circumstances the Crown has resumed
subsurface rights5.
Holders of surface rights in the Australian states have only a
limited ability to influence the extent of exploration and mining
activity on their land. Generally, this is restricted to the granting
of permission to access the land to explore and to the recovery of
compensation for any costs the landowner may incur due to
exploration and mining activity. In some cases, however, the
compensation process and related potential delays may amount
to a de facto power of veto.
Where land has been granted native title under the Native Title
Act 1993, the Crown maintains subsurface rights, but native
titleholders can insist on compensation for any disturbance to
surface rights and compensation may be paid. A negotiation
process involving native title claimants, mining companies and
state governments can give rise to indigenous land use agreements.
These agreements do not confer native title on the land, but they
grant recognition to the interests of Aboriginal people that are
parties to the agreement. In these agreements, a wide range of
outcomes is possible that can give rise to Aboriginal people
effectively obtaining access to economic rents (Denolder, 2000).
One of the most recent and relevant agreements is that negotiated
over a diamond mining operation in the Kimberley region of
Western Australia (The Australian, 2005a).
Powers to raise mineral taxes
Section 90 of the Commonwealth Constitution proclaims that
‘duties of customs and excise shall be the exclusive responsibility
of the Commonwealth Government’. The Australian High Court
4. The baseline has been drawn to incorporate offshore islands into state
jurisdictions.
5. The New South Wales Coal Acquisition Act 1981 vested ownership of
all privately owned coal in the Crown and provided for compensation
where appropriate.
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
has interpreted this clause broadly, so that the states are effectively
precluded from using any tax applied on goods and services.
The consequence is that when they seek to extract rents from
mining operations, it is necessary for the states to assert that what
is being imposed is not a tax, but instead a charge on
private-sector mining companies relating to the conversion of
public property into private property (Crommelin, 1996).
Calzada (2000) discusses the legal arguments over the issue of
whether royalties constitute a tax or a charge.
Generally the states have imposed these charges through the
relevant administrative department that deals with the minerals
sector. The charges then appear in state budgets as departmental
revenues rather than tax revenues.
States can also obtain revenues as a result of a statutory
agreement with a specific company, where the enabling statute
contains a mineral royalty provision based on the transfer of
minerals from public to private ownership. Statutory agreements,
sometimes referred to as state agreements, are particularly
relevant in Western Australia, but there are also instances in other
states.
At the Commonwealth level, the relevant legislation provides
directly for the collection of revenue through the taxation of the
mineral sector. The main tax instrument of the Commonwealth is
the petroleum resource rent tax (PRRT) which, as the name
suggests, applies only to petroleum (oil and natural gas). Because
the mineral rights were transferred under the pre-existing royalty
regime the Commonwealth has exempted the north west shelf
area from the PRRT and instead retains taxes based on the value
of production rather than the value of economic rents.
DESIGN PRINCIPLES FOR THE TAXATION OF
MINERAL RENTS
There are a number of well established principles for the design
of a good tax system. They are: economic efficiency, equity,
administrative cost, transparency and revenue stability.
Economic efficiency
One objective of a taxation system designed to collect economic
rents for a government should be to ensure that, as far as
possible, there is no impact on the exploration and production
activities of mining operations. That is, the same activities would
occur whether the rent-collecting tax was in place or not. This is
the condition of neutrality, meaning that the system being used
to collect economic rent does not change the behaviour or
decisions of a mining company.
This neutrality concept is also encapsulated by the terms
efficient and non-distorting. Efficient in the sense of allocative
efficiency, where the tax does not change the way economic
resources are employed away from the optimal market allocation.
By contrast, rent-collecting systems that do not achieve this
condition are non-neutral, inefficient and distorting. In practical
terms, a non-neutral, inefficient or distorting system gives rise
to either:
• extracting too much of the resource (over-exploitation), or
• not extracting enough (high-grading),
relative to what would be the case in the absence of the tax
system.
Unless there is a case for over- or under-extraction based on
some criteria other than collecting economic rents, these results
are undesirable where the only objective of government is raising
revenue through the collection of economic rents.
There are circumstances where imposing a tax that changes the
behaviour of a mining operation is in the social interest. This
applies particularly where negative externalities would otherwise
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apply. Negative externalities are those costs of mining activity
that are not borne by the mine operator in the form of costs of
production covered by mine revenue, but rather costs that are
borne by society as a whole through, for example, pollution or
environmental degradation.
Negative externalities are examples of market failure where
competitive market forces alone do not deliver a socially optimal
outcome. In these circumstances, policymakers often consider
some form of social intervention through taxation or other
appropriate regulatory instruments.
There may be an arguable case that the operation of
competitive markets for minerals in the face of uncertainty about
the future:
• leads to over-exploitation of non-renewable mineral resources
in the current period; and
• fails to consider the interests of future generations.
The consequence is that future generations may be relatively
impoverished because the stock of non-renewable resources
passed on to them is lower than otherwise. This issue has been
the subject of long-standing discussion and any firm conclusions
are generally deferred while the prospects of making new
discoveries through further exploration exist (Tilton, 2003).
Equity
The equity issue is concerned with whether a tax is fair on
taxpayers. There are a number of dimensions to fairness. The
first is whether the tax is fair with respect to horizontal equity.
Horizontal equity implies equal treatment of equals and would
ask the question ‘are miners who generate the same amount of
economic rent all paying the same amount of tax?’6. By contrast,
vertical equity is concerned with whether miners who generate
different amounts of economic rent are treated differently in the
amount of tax they pay. The principle of vertical equity is
violated when a tax system fails to discriminate between high
rent and low rent operations and instead imposes a tax on a base
that does not give explicit recognition to the levels of economic
rents associated with different mining operations.
Another dimension to equity is fairness over how the tax
revenues raised from economic rents are utilised. In particular,
whether the revenues should be combined with all other revenue
and dispersed in the normal budgetary processes, or
appropriated, at least in part by the local government or
communities of the various areas hosting the mining operations.
There has recently been a build-up of political pressure for the
return of some of the rents directly to the regions and the
communities affected by mining. The payment of royalties to
Aboriginal communities is one reflection of this pressure.
Company contribution towards locally based community services
is another example of the results of this pressure.
The final aspect is intergenerational equity. Depletion of
mineral resources has the potential to leave future generations
without the ability to earn comparable levels of income as the
asset stock inherited by future generations is diminished.
Intergenerational equity is an aspect of economic sustainability.
The general policy prescription for sustainability, where income
initially depends on the exploitation of natural resources that face
eventual depletion, is that the economic rents should be used to
acquire other income-earning assets that will ensure a flow of
income to future generations when the natural resources are
depleted (Hartwick, 1977).
6. Until 1991, profits from gold mining were exempt from the
Commonwealth company income tax, but not other mining profits.
Only recently has gold mining been subject to a royalty in Western
Australia and there is no royalty on gold mining in Victoria.
176
Administrative cost
Administrative cost has two components. First, there is the issue
of whether the cost to government of operating the tax system is
high relative to the revenue received. In a worst-case outcome, a
tax system may cost more to run than it receives in revenue.
Ideally, the cost should be as low as possible consistent with the
other objectives of a tax system.
The second element is the cost to the mining company of
complying with the tax requirements, other than the revenue
actually handed over to the government. Compliance costs
include the administrative, accounting and legal costs borne by a
mining company and similarly should be kept as low as possible
consistent with the goals of the tax.
Transparency
This principle relates to whether miners are fully informed about
the tax liabilities that may follow from any proposed activity.
Transparency also refers to the openness of the taxation
arrangements and collections to examination by the community.
The transparency case argues for liabilities to be predictable and
(ideally fixed for the life of the mine) before any proposed
mining activity takes place. Subsequent changes to the mining
tax regime create additional costs for the miners like all taxation
changes in the economy. Near full compliance with this criterion
is found in the statutory state agreements discussed below. By
contrast, where governments arbitrarily change the laws to
impose tax burdens that were not indicated originally, then the
condition of sovereign risk applies.
Stability
Finally, governments often see stability in their revenue flows as
desirable. This is because large inflows of revenues in one period
in a highly volatile context may encourage government spending
programs or cuts to other taxes that cannot be sustained when
revenues from mining taxes fall away.
The problem with these criteria is that their application may give
rise to conflict between them. For example, a tax designed to meet
the efficiency criterion may suffer from high administrative costs, or
be subject to unstable revenue flows. This leads to trade-offs in the
design of mineral taxation systems so that the criteria set out above
are never fully maximised in a mineral taxation system. The nature
of the trade-offs accepted in any particular mineral taxation regime
reflects the administrative capabilities of the taxation authorities,
and the strength of the influence of the minerals sector in the
political decision-making process.
CURRENT MINERAL TAXATION REGIMES IN
AUSTRALIA
In designing any mineral taxation regime, the critical ingredients
are the tax base and the tax rate. The tax base refers to the object
from which tax revenue is being collected, while the tax rate is
the proportion to be applied to the base to calculate mineral
revenue proceeds. Ideally, in the context of the minerals sector, the
base should be the economic rent derived from mining activity,
and the tax rate should be the optimal rate at which economic
rents are shared between the government and a company subject to
a mineral taxation regime. While in principle it should be possible
for a government to take 100 per cent of any economic rent, in
reality, governments take something less so as to maintain the
incentive for efficiency in mining operations and to account for the
complexity in correctly measuring the level of economic rent.
Taxes designed to capture economic rent
There are several types of tax that attempt to capture economic
rents in the minerals sector. They include specific (unit-based)
royalties, ad valorem royalties, profit taxes and resource rent
Australian Mineral Economics

taxes. Some other taxes, such as the company income tax, also
capture some of the available economic rents, but they are not
designed specifically for the minerals sector. At the same time, as
will be demonstrated later, even those taxes ostensibly designed to
capture economic rents do not always succeed in their objective as
they are only approximately targeted on economic rent and instead
have the effect of being taxes on costs of production.
Specific (unit-based) royalties – Here, the royalty is levied on a
base relating to the physical rather than the financial measure of a
mineral resource. The most common form is as dollars per unit
measure of weight or volume (dollars per tonne, dollars per barrel).
In some cases, the specific royalty may be subject to an adjustment
over time according to changes in the price of a mineral.
Ad valorem royalties – In their simplest form, ad valorem
royalties consist of a uniform percentage (the rate) of the gross
sale price (the base) of a mineral product where the sale is made
by the entity that extracted the resource. For example, copper
produced in Western Australia attracts a royalty of 2.5 per cent of
its realised value.
Although the ad valorem form is a relatively straightforward
concept, when it comes to its application, governments introduce
complexities to achieve other objectives. For example, they may
reward further local processing with a reduced level of royalty.
In many jurisdictions, there is an allowance for the deduction
of those costs associated with the domestic transport of the
mineral from the mine to the point of sale if processed
domestically or from the port of embarkation to the point of sale
if exported. Such a system attempts to generate an approximate
ex-mine value. A similar situation occurs in the petroleum
sector, where the royalty is based on the well-head value, which
is the point where the petroleum reaches the top of the well. The
well-head value then is the revenue from sales after deducting
costs downstream from the well-head.
Also governments may accept the sale value as the actual
amount displayed by the company invoices, or alternatively the
value determined independently using a market price for the
mineral product rather than the price actually received by the
company. Where forward sales are involved, the government
may, or may not, take the gains or losses on forward sales into
account in determining the base.
Profit regimes – Profit regimes are based on a measure of
profit, which normally includes both normal profits and economic
rent. This tax base may not be comparable with the accounting
profit base on which general company income tax is levied.
A profit regime may incorporate a minimum specific or ad
valorem royalty component to limit the risk that government may
collect no revenue if there are no taxable profits and to ensure a
minimum stability of revenue. Such systems are referred to as
hybrid regimes.
Resource rent tax – Resource rent taxes seek to identify
economic rents by allowing the deduction of all costs of
production from revenue, including normal profit, and then
taking a share of any resulting rents. Measurement problems
occur when defining an appropriate measure of the level of
‘normal profit’ to be allowed.
Other methods – Australian state governments have used
other less orthodox methods in the past in seeking to capture
economic rent. These include rail freight rates, pipeline licence
fees, export levies and government equity. Cash bidding for
exploration tenements is a common system of extracting some
upfront economic rent, though it is rarely used in Australia. Cash
bids can be unconditional or can be part of a subsequent taxation
system based on economic rent or other tax mechanism.
7. A summary table, though somewhat dated, of royalty systems in the
Australian states, The Northern Territory and the Commonwealth is
available at: http://www.industry.gov.au/assets/documents/itrinternet/
18_Minerals_Taxation20050316170636.pdf
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
All of these methods are discussed below in the context of the
mining taxation systems that have been used in the Australian
states, the Northern Territory and the Commonwealth. While
there is stability in the basic design of mineral taxation systems
in the states, there are frequent changes to the detail in response
to industry submissions and greater sophistication in the design
of taxation regimes.
Any amount that a mining company pays to a state
government in the form of mining royalties is deductible as an
expense in the calculation of Commonwealth income tax
liabilities. With the current company tax rate of 30 per cent, for
every dollar paid in royalty to a state government, the
Commonwealth effectively foregoes 30 cents. If there were no
state government royalties, the Commonwealth Government
would have collected those 30 cents. In effect, every dollar of
royalty paid to a state government only costs the mining
company 70 cents as long as it has a company income tax
liability. The same position applies with payments due under the
Commonwealth’s petroleum resource rent tax. These are also
deductible in the calculation of company income tax.
This interaction between Commonwealth and state systems is
always important in considering the impact of taxation generally
on mining companies.
Tax and royalty regimes in the Australian states,
the Northern Territory and the Commonwealth7
Queensland
In Queensland the details on the royalty regime are found in the
Mineral Resources Regulation (2003).
The royalty on coal, the most important mineral in
Queensland, is seven per cent of the sale value, less a number of
deductions, but not rail and road haulage costs. The ad valorem
rate for base and precious metals can be either fixed or variable,
subject to the mining company’s choice. There are also
concessions for small mines and discounts where further
processing takes place. The fixed ad valorem rate is 2.7 per cent,
while the variable rate is between 1.5 per cent and 4.5 per cent of
the market price of the mineral as quoted on various metal
markets. As an example, for copper, lead and zinc, the value is
determined by the settlement price on the London Metal
Exchange on the relevant trading days. Similar values apply for
gold and silver. By using the sale price in long-established
markets as the value base, the Queensland system does not take
into account any revenues or losses that may be related to
hedging in forward markets. The variable rates system enables
adjustment to the royalty rate to take into account fluctuations in
the value of the Australian dollar.
For the purpose of determining the royalty for base and precious
metals there are certain allowable deductions. These include
exchange gains and losses under a fluctuating exchange rate and
ocean freight costs. They do not include rail and road haulage
costs and other marketing costs. Other lower-value commodities,
by contrast, attract specific unit-based rates of royalty.
Queensland also operates a ten per cent well-head value royalty
system for petroleum and coal bed methane (Queensland
Government, 2005).
Revenues from minerals and petroleum royalties in
Queensland in 2004-05 were $965.7 million.
New South Wales
In New South Wales, coal is the dominant mineral that provides
revenue to the state government (New South Wales Government,
2005). Until 2004, the state raised revenue through a specific
royalty of $1.70 a tonne for underground mines and $2.20 a
tonne for open cut mines.
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In the new regime effective from 1 July 2004, the royalty
system is based on coal prices. Deep underground mines will pay
a royalty of five per cent of the pre-transport value of coal,
underground mines six per cent and open cut mines seven
per cent.
For other minerals, the royalty rate is four per cent of the
ex-mine value, where an ex-mine value is calculated as the sale
value less allowable deductions. In the case of low-value
minerals, specific royalty rates of 35 cents per tonne or 70 cents
per tonne apply.
New South Wales also has a profit-based royalty system,
which applies only to specific mining operations in Broken Hill.
In the petroleum sector, the royalty rate is ten per cent of the
well-head value, though this is only applicable after ten years,
with rates rising from zero in the first five years to six per cent in
the sixth year up to ten per cent in the tenth year. The same
regime is in place for methane extracted from coal seams when
the extraction is not associated with coal mining. When
associated with coal mining, no royalty applies.
As can be seen in Table 15.1, revenues from minerals and
petroleum royalties in New South Wales in 2004-05 were $396
million.
TABLE 15.1
New South Wales Government mining royalty collections,
2004-05 financial year ($ million). (Source: New South Wales
Department of Mineral Resources Annual Report 2004-05.)
Sector Revenue ($ million)
Coal 354
Non-coal 42
Total 396
Victoria
The Mineral Resources Development Regulations 2002 based on
the Mineral Resources Development Act 1990, prescribe a 2.75
per cent ad valorem royalty to the net market value of all
minerals, except for gold which is royalty free (Victorian
Government, 2005). The net market value relates to prices
prevailing at the time when the mineral is first sold, transferred
or disposed of, less any costs reasonably, necessarily and directly
incurred in connection with the sale, transfer or disposal
(including insurance, freight and marketing expenses) of mineral
products.
The specific royalty rate for brown coal was set in June 1993
at $0.0239 per gigajoule with values subsequently indexed by the
CPI. Specific royalty rates applying to quarry products from
Crown land are prescribed under the Extractive Industries
Development Act 1995. A petroleum royalty for onshore oil and
gas is set at ten per cent of well-head value under the Petroleum
(Submerged Lands) Act of 1982 (Vic) and the Petroleum Act
(1997).
The value of mineral royalties in the 2003-04 financial year,
which amounted to $20.9 million, appears in Table 15.2.
TABLE 15.2
Victorian Government mineral royalties by sector, 2003-04
financial year. (Source: Department of Primary Industries,
Minerals and Petroleum Statistical Review 2003-2004.)
Sector Revenue ($ million)
Mining 16.0
Extractive 3.3
Onshore petroleum 1.6
Total 20.9
178
Tasmania
The Mineral Resources Development Act 1995 prescribes, through
the Mineral Resources Regulations 1996, a complex combination
of ad valorem and profit-based royalties for most metallic mining
products (Tasmanian Government, 2005a). The ad valorem rate is
1.6 per cent of net sales, while the profit component provides
additional revenue, up to a maximum of five per cent of net sales.
In addition, there is a rebate system for those mining operations
that undertake significant downstream processing.
Schedule 1 of the Hellyer Mine Agreement Ratification Act
1987 prescribed a 3.5 per cent ad valorem royalty based on sales
revenue plus a complex profit component (Tasmanian
Government, 2005b). The mine closed in June 2000.
Specific royalty rates of between $0.60 and $2.40 per tonne
apply to most non-metallic and quarry product, with $5.00 per
cubic metre for building and dimension stone. Petroleum royalty
rates are set within a band of 11 to 12.5 per cent of the well-head
value onshore under the Petroleum (Submerged Lands) Act 1982.
The Tasmanian Government collected royalties totalling $9.0
million during the 2003-04 financial year (Tasmanian
Government, Mineral Resources Tasmania, 2004).
South Australia
From 1 January 2006, royalties in South Australia will be
payable on an ad valorem basis of 3.5 per cent (previously 2.5
per cent) of the value of the minerals as assessed by the Minister
as empowered by the Mining Act (1971) (South Australian
Government, 2005). Value assessments are on a case-by-case
basis, with reference to the market value of the mineral output or
concentrate.
The Roxby Downs (Indenture Ratification) Act 1982, was
specifically designed for the Olympic Dam copper, uranium and
gold project. It provides for an ad valorem royalty of 3.5 per cent
of minesite revenue and, in addition, a profit-based royalty is
payable once a threshold rate of return is reached (South
Australia Government, 2004).
A petroleum royalty of ten per cent of well-head value came
into operation in 2002 and applies to state coastal waters within
three nautical miles. A royalty of 2.5 per cent applies to the
well-head value of geothermal energy.
In 2003-04, the South Australian Government collected $46.74
million in petroleum royalties and $28.45 million from other
mineral royalties, for a total of $75.17 million (South Australian
Government, 2004).
Western Australia
In Western Australia, the Mining Act (1978) and related Regulations
(1982) specify two general royalty systems for minerals that are not
the subject of statutory state agreements (Western Australian
Government, Department of Industry and Resources, 2005a):
• a specific royalty, mostly of $0.30 or $0.50 per tonne, is
applied to most low-value, bulk, generally non-metallic
mining products;
• an ad valorem royalty is applied to the value of most
higher-value, generally metallic minerals, with the rate of
royalty reducing as a function of increased downstream
processing of the product sold:
• crushed and screened, bulk material: 7.5 per cent;
• concentrates: 5.0 per cent; and
• metal: 2.5 per cent.
There are, however, many special cases that do not fit into the
two general categories. These include coal, gold, cobalt and
copper if sold as nickel by-products, ilmenite concentrates used as
feedstock into an ilmenite beneficiation plant in Western Australia,
tantalum and tin when sold in any form other than metal.
Australian Mineral Economics

The Western Australian Government has used state agreements
Acts as the preferred method of setting out terms and conditions
(including obligations on the government) under which specific
mining and minerals processing projects proceed (Western
Australian Government, 2005). These agreements cover most of
the important mining projects in Western Australia in iron ore,
nickel, diamonds, mineral sands and bauxite-alumina. Their
statutory nature means that the obligations are legally binding
and, where expressly designated, can only be changed by mutual
agreement followed by legislative amendment.
However, when either of the parties is seeking changes to
agreement conditions trade-offs can occur and by agreement a
variation to the Act of Parliament can be made. In 2005, the
renegotiations of iron ore special agreements with BHP Billiton
and Rio Tinto to amend them for production expansion and
development of new mines gave the state government an
opportunity to renegotiate the applicable royalty rates. The state
sought to increase the rate from the original concessional rate for
iron ore fines of 3.75 per cent to 5.625 per cent, the normal rate
paid by other iron ore miners under the regulations (Hansard,
2005; The Australian, 2005b). By contrast, the Argyle diamond
project achieved a change to the royalty regime in its state
agreement as it embarks on a less profitable underground extension
of the previously open cut project (The Australian, 2005c).
Royalty arrangements have always been an integral component
of state agreements, as the royalty obligations have always been
negotiated in the context of other obligations imposed on the
mining or processing project that is the subject of the agreement.
These other obligations have variously included requirements to
provide township and transport infrastructure and commitments
to further processing of mineral products. Bradley (1986)
referred to these other obligations as de facto royalties.
The royalty regimes in the state agreements are of the specific,
or a hybrid specific ad valorem type ($ per unit adjusted by
changes in market price of a metal) or standard ad valorem. In
the cases of the Argyle Diamond and Ellendale Diamond
projects, a profit-based royalty of 22.5 per cent applies over the
life of the project, subject to a minimum ad valorem royalty
payment of 7.5 per cent in any year.
Petroleum royalties in Western Australia are levied under four
different Acts. Following the offshore constitutional settlement in
1979 and successive negotiations, the state and Commonwealth
governments agreed to allocate petroleum royalties derived from
onshore and territorial sea production, Barrow Island production
and the offshore north west shelf (under Commonwealth
jurisdiction but administered by the state as the designated
authority) as set out below:
• Petroleum production on-shore and in coastal waters out to
the landward limit of the territorial sea attracts a ten to 12.5
per cent well-head value royalty under the provisions of the
Petroleum Act 1967. These royalties are 100 per cent
appropriated by the state.
• A similar royalty is applied to petroleum production within a
defined state territorial sea, under the Petroleum (Submerged
Lands) Act 1982. The Commonwealth takes 40 per cent of
these royalties.
• The Western Australian Barrow Island Royalty Variation
Agreement Act 1985 applies a resource rent type tax to
production from Barrow Island. This regime arose from
negotiations between the WAPET Consortium, the state and
the Commonwealth to replace a complex well-head royalty
and excise system that had previously applied. The state
keeps only 25 per cent of revenues from the tax, and remits
the remaining 75 per cent to the Commonwealth.
• Offshore production from the North West Shelf project areas,
covered by permits WA-1P and WA-28P, attracts a ten to
12.5 per cent well-head value royalty under the Petroleum
Submerged Lands (Royalty) Act 1967. Although this area is
Australian Mineral Economics
CHAPTER 15: MINERAL TAXATION AND ROYALTIES
under Commonwealth jurisdiction, it is administered by the
state as the designated authority. The north west shelf project
is the major oil and gas producer in Western Australia and it
generates substantial revenue under these royalty arrangements.
Sixty per cent of the primary ten per cent royalty is returned
to the state, while the Commonwealth keeps the balance. In
addition, the state is returned 100 per cent of the secondary
2.5 per cent royalty, bringing the total split to 68 per cent to
the state and 32 per cent to the Commonwealth.
Table 15.3 sets out mineral royalties received by the Western
Australian Government, net of any remittance to the
Commonwealth.
TABLE 15.3
Western Australian mining and petroleum royalties, 2004-05
financial year. (Source: Western Australian Government,
Department of Industry and Resources, 2005b).
Sector Revenue ($ million)
Iron ore 380
Petroleum 550
Alumina 55
Diamonds 33
Mineral sands 27
Nickel 93
Gold 73
Other 46
Total mineral royalties† 1256
† Excludes royalties collected on behalf of the Commonwealth (North
West Shelf).
Northern Territory
The Northern Territory has a profit-based royalty regime for
minerals (Northern Territory Government, 2005). The system
applies a rate of 18 per cent to the net value of minerals, where
the net value is the gross realisation value (or sale value), less:
• operating costs,
• a capital recognition deduction on eligible expenditure,
• eligible exploration expenditure, and
• any additional deduction approved by the minister.
The capital recognition deduction combines depreciation and
normal profit. Normal profit is defined as the long-term bond rate
plus two per cent.
Because ownership of uranium still rests with the
Commonwealth Government, the Commonwealth collects
royalties on uranium mined in the Northern Territory and returns
them to the Northern Territory. The Commonwealth royalty on
uranium is an ad valorem royalty of 5.5 per cent. The Northern
Territory Government receives a royalty equivalent from the
Commonwealth of 1.25 per cent while the Commonwealth pays
the balance to the Aboriginals benefit trust account (ABTA).
A ten per cent wellhead ad valorem royalty applies to petroleum
production.
Revenue generated from mining activity (including petroleum
production) in 2003-04 was $41.3 million.
The Commonwealth of Australia
The petroleum resource rent tax (PRRT) was first introduced in
1987 and has been amended significantly since then. As already
discussed, the petroleum resource rent tax does not apply to the
area covered by the north west shelf project, which has an ad
valorem excise regime.
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The important characteristic of rent-based taxation regimes is
that costs of production, including normal profits, are deducted
from cash flow before determining the tax base. Current and
capital outlays are deductible in the year in which they are made,
and so depreciation does not feature as a cost. Interest is not
counted as a deductible cost as it is part of the normal profit that
is included in the calculation of total cost. The Commonwealth
has also introduced a special allowance for remote area
exploration, whereby 150 per cent of exploration expenses may
be deducted from any revenue subject to resource rent tax
(Commonwealth Government, 2005a).
For years in which costs are greater than revenues, the negative
cash flow is carried forward into the following year after being
increased by the rate of return. In effect, the legislation treats
negative cash flows as an investment upon which the operator is
allowed to earn the required rate of return, or normal profit
before paying tax.
The level of normal profit set in the PRRT legislation is the
combination of a risk-free rate of return (the Commonwealth
ten-year bond rate) and a premium of 15 per cent for
expenditures associated with exploration, or five per cent for
expenditures associated with development and production.
The result is that there is no liability for tax payments under
the PRRT until the petroleum field operator has recovered all
outlays, including any investment in the form of negative cash
flows and a normal return on that investment. Outlays on
unsuccessful exploration in Australia are also deductible from
the revenue generated by an individual project before
determining the resource rent tax base. Any surplus then arising
is taxable and is divided between the operator and the
government on a 60:40 basis using the tax rate of 40 per cent.
Revenue to the Commonwealth in 2004-05 from the petroleum
rent royalty tax was $1460 million, while excise revenue in the
form of the ad valorem royalty on areas not subject to the PRRT
(predominantly the north west shelf project) was $309 million.
Other issues in the collection and use of
economic rents in Australia
In the past, constitutional provisions and policy approaches have
led to the development of innovative indirect ways of collecting
mineral revenues other than through the standard mineral
revenue collection systems outlined above. In addition, there
have been suggestions to use alternative or modified approaches
to conventional royalty regimes. This section also discusses how
the states that raise revenue through tax or royalty regimes on the
mining sector do not always get to keep their revenues.
Export levies
In 1975, the Australian Government imposed levies on coal
exports. As these exports came from resources in Queensland
and New South Wales, the Commonwealth could not have sought
to collect what it perceived to be economic rents in the coal
export business directly, but could do so through constitutionally
appropriate, though economically inefficient, export levies. The
relevant state governments were not able or willing to extract
these rents for themselves. The levy was abolished from 1 July
1992.
Rail freight rates
For a number of years, the Queensland Government extracted
rents from the coal industry by imposing a surcharge on rail
freight rates for coal. Although initially omitted from
Commonwealth Grants Commission calculations for mineral
8. Hematite Petroleum Pty Ltd v Victoria (1983) 151 CLR 599.
180
revenues, they were finally captured in 1999 and treated as a
quasi-royalty. Subsequently, the Queensland Government phased
out excess rail charges and introduced a single royalty regime for
all coal mines (Commonwealth Grants Commission, 2003).
Pipeline licence fees
In Victoria, in 1981, the state government attempted to impose a
pipeline licence fee on onshore pipelines carrying crude oil from
the Bass Strait oil fields. The licence fee was set at $20 million.
The oil producers appealed against the legality of the fee to the
High Court. Its judges ruled in favour of the oil producers8. The
Victorian Government was forced to repay money raised by the
fee to Esso/BHP.
Infrastructure contributions
In Western Australia, Bradley (1986) identified the practice of
the government, by means of state agreements, requiring mining
operations to fund social infrastructure and to enter into further
mineral processing commitments. Bradley referred to these
requirements as de facto royalties and argued that their
consequence was effectively to reduce the formal royalty
arrangements.
Cash bidding
One method rarely used in Australia is to auction the exploration
and development rights of well defined tenements either for an
upfront cash payment, or an ongoing ad valorem royalty or some
combination of upfront cash and royalty payments. Bidding
systems are in common use in the United States, particularly for
petroleum tenements on the outer continental shelf.
The argument in favour of cash bidding is that it allocates
tenements to those prepared to make the highest bid. This should
indicate that the exclusive rights to exploration and development
of mineral tenements are held by those who have the best
understanding of the prospectivity of a tenement and who have
the ability to operate it efficiently, or at least have the financial
resources to do so.
The cash bid should reflect the present value of the expected
economic rents from a tenement and, unlike production or
cash-flow-based systems, gives the government money at the
start of the mining process. In addition, being a sunk cost, the
cash bid will have no impact on later investment and production
decisions, and therefore has the desirable attribute of neutrality.
By contrast, ad valorem royalty bidding systems are subject to
all of the same criticisms that apply to ad valorem royalties
generally.
Provision for an up-front cash bidding approach to the
allocation of petroleum tenements exists in the Commonwealth
Petroleum (Submerged Lands) Act 1967, but it has been used
sparingly. It was last used in 1993 (Commonwealth Government,
2004).
The Australian states have not adopted cash bidding. Even
though up-front bidding has significant benefits relative to the
other methods of allocating petroleum exploration tenements, the
states have preferred to stick with the work commitment bidding
approach that gives emphasis to maximising the quantity of
exploration activity rather than the collection of economic rents.
Government equity participation
Rather than rely on a tax system that may be inadequate to
collect part of the available rents, governments in a number of
jurisdictions throughout the world have taken direct equity in
mining operations. For the most part, this is free equity given to
the government in return for the right to mine.
Australian Mineral Economics

In recent years in Australia there has only been one case of
government equity participation as a means of accessing and
distributing rents directly to citizens. This was in the context of the
Argyle diamond mine in Western Australia. The original
exploration joint venture included, along with the majority
participant CRA, a small company known as Northern Mining
with a five per cent participation. When the project turned from an
exploration to a mining activity in 1983, the Western Australian
Government bought Northern Mining. The company was
subsequently sold on the stock exchange as the Western Australian
Diamond Trust. In 1989 the trust was bought out by CRA.
Hybrid resource rent tax
The Bradley Report into mineral revenues in Western Australia
recommended that the existing systems of royalties in Western
Australia be replaced by a resource rent type tax in combination
with an ad valorem system. The benefits claimed for this hybrid
approach were that, as well as providing a more efficient and
equitable tax regime, the government would receive an early
flow of income from new mining projects, thus producing a more
stable and certain revenue flow to government. The ad valorem
royalty would be set at a low rate and apply only until the
company had recovered all of its outlays and was generating
economic rent. Amounts paid initially under the ad valorem
system would then be repaid to the company through reduced
resource rent tax payments until all ad valorem payment was
returned. In effect, the ad valorem payment was a loan made by
the company to the government against future rent tax payments
and subsequently repaid.
Using economic rents for the future
While it is granted that known mineral resources are being
depleted, there is a long-term question about the future of
mineral revenues as mining activity proceeds. There is the
prospect that price increases will offset a declining resource base
and thus maintain mineral revenues. There is also the prospect of
the known resource stock being enhanced through further
exploration, or technological changes that make lower grade
orebodies economic to mine.
In any case, the ultimate reduction in the flow of mineral
revenues and the corresponding effects on state or
Commonwealth income levels can be offset if the mineral
revenues are reinvested in new human or physical capital along
the lines of the suggestion by Hartwick (1977).
To some extent this approach has been implemented by the
Alberta Heritage Fund (2005), the Alaska Permanent Fund
(2005), and the Government Petroleum Fund in Norway (2005).
Yet, the experience of Nauru suggests that mineral revenues put
into a central fund opened the possibility of corrupt and
uneconomic use of those revenues, prompting the view that it
would be better to direct the funds to individual or family units
that might make more efficient choices (Hughes, 2004).
Net impact of Australian federalism on state royalty
revenues
The net value of royalties to state governments in Australia is
influenced by the Commonwealth Grants Commission (CGC)
process. The Commission recommends the formula for
distributing revenues from the goods and services tax (GST)
between the states on the basis of a state’s overall tax effort,
fiscal capacity and revenue need.
9. For a discussion of the issues associated with mineral taxation by
state governments and the procedures of the Commonwealth Grants
Commission, see Committee for the Review of Commonwealth-
State Funding (2002).
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
The proceeds of the GST collected by the Commonwealth
Government are distributed to state governments, not on the basis
of equal per capita amounts, but on the basis of ability to raise
their own revenue and the costs of supplying state government
services. The objective is to achieve some degree of
comparability in the standard of government services between
the states. Where a state raises considerable revenue out of its
mineral sector relative to that raised in other states, it effectively
does not keep all of that revenue. The Grants Commission
methodology has the effect of reallocating part of that revenue to
those states that have a less than national average ability to raise
money from the mining and other sectors. This is achieved by
reducing the share of GST allocation to the mineral
revenue-earning state9.
EVALUATING AUSTRALIAN MINERAL TAXATION
AND ROYALTY SYSTEMS
Assessment of different taxes
An important way to assess the operation of the Australian
mineral taxation and royalty systems is on the basis of the
criteria discussed earlier – that is, on the grounds of efficiency,
equity, administrative cost, transparency, and revenue stability.
Specific royalties
A levy based on physical measures such as dollars per tonne
offends notions of efficiency and equity as it adds to costs of
production and fails to discriminate between high rent, low rent
and no rent operations. This type of royalty leads to high-grading
with ore left in the ground that would, in the absence of the
royalty, be extracted. It may be relatively easy to administer and
comply with and as long as production remains constant it will
deliver a steady flow of income. Revenue will remain constant
irrespective of whether the unit price of the relevant mining
product rises or falls significantly. As a consequence, politically
difficult royalty rates adjustments become inevitable from time
to time. Because of these considerations, specific royalties are
generally applied to low- value, bulk mining and quarry
products.
Ad valorem royalties
These suffer, albeit to a lesser degree, from the same problems as
the specific royalty with respect to efficiency and equity, and
they may become complex to administer if governments attempt
to tailor the royalty to achieve efficiency and equity objectives.
The amount of royalty payable does rise and fall in line with
movements in commodity prices, giving the ad valorem system
an advantage over the specific royalty, but the ad valorem system
still fails to discriminate between high rent, low rent and no rent
mining operations, thus failing the equity criterion. The system
also fails the efficiency criterion because the ad valorem system
is a tax that adds to costs of production. It adds to costs of
production because, as a tax on sale revenue, the tax applies to
both the costs of production and any economic rents that are
included in sale revenue.
Profit based royalties
These, in theory, should be an improvement over the previous
two systems from an economic efficiency and equity point of
view, but still have the problem of taxing costs of production by
taxing normal profits as well as economic rents. This approach
may, however, introduce significant administrative complexity,
ambiguity, compliance cost and potential for litigation. These
outcomes arise because the profit calculation on which the
royalty is based generally has significant differences from
conventional profit calculations and it is also different from the
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calculation of net income used for the purpose of levying income
tax. A profit-based regime may also have a negative effect in
terms of government’s revenue stability objectives.
Rent-based regimes
Rent-based regimes should be efficient and equitable as long as
the estimate of the rate of normal profit is accurate. If the rate is
set too high, then there is an implicit subsidy and an incentive to
over-explore and over-produce. If set too low, there will be a
disincentive to explore and produce. From the perspective of the
community, the long delay in the receipt of revenues is a hazard,
though it can be offset through the use of hybrid varieties. There
is debate over the extent to which a rent-based approach acts to
deter new investment based on the change brought about in the
probability distribution in the risk/return trade-off (Smith, 1999).
Problem areas
Taxation and royalty systems based on values or revenues can
give rise to administrative problems with transactions, which are
not at arm’s-length, particularly for commodities not frequently
traded on recognised markets. Some companies may seek to
manipulate the values on which taxes and royalties are based to
produce lower revenue for the jurisdiction in which mining takes
place. Hughes and Singh (1978) have noted that high levels of
vertical and horizontal integration combined with
transjurisdictional operations (mining in one jurisdiction,
processing in a second and selling in a third) in some parts of the
mineral sector can give rise to transfer and monopoly pricing
systems that effectively transfer economic rents to other
jurisdictions, particularly those with low or zero tax.
Governments have recognised this problem and have
responded by incorporating provisions in mineral revenue
systems to establish values for mineral production or economic
rent, based not on the prices as declared in royalty returns but on
a deemed value. Where mineral commodity markets are thin, and
the value of commodity contract prices difficult to obtain or
confidential, government may make use of independent experts
to advise on values. For some intermediate mineral products (raw
ores and concentrates) for which markets may not exist, a
suitable proxy may be provided by determining the value of the
product sold on the basis of the value of the actual metal
contained in it at the price prevailing at the time of shipment.
This practice is common for many commodities including nickel
and gold in Western Australia as well as for copper and cobalt
when contained as co or by-products in nickel concentrates.
There is also a transfer pricing problem with a resource rent
type mineral revenue system, even if the mining, processing, and
sale are carried out in the same jurisdiction. Where a raw mineral
goes straight into processing, the issue of its value for the
purpose of calculating the economic rent tax liability arises.
Where there are competitive markets for the raw mineral that are
alternative supply options instead of direct processing, then
government can use these market values. Where there are not
good proxy values based on competitive markets, government
must find some alternative mechanism.
In the case of natural gas that goes into integrated liquefied
natural gas projects, the Australian Government has incorporated a
netback approach into the PRRT. This approach deducts costs of
processing from the sale price to arrive at a value prior to further
processing that can then be used to calculate PRRT liability
(Commonwealth Government, 2005b).
COMMONWEALTH COMPANY INCOME TAX
The discussion so far has focused on those taxation and royalty
systems explicitly designed to raise revenue from the economic
rents from the minerals sector. There are a number of other
182
imposts that are applied across all industrial sectors that
incidentally raise revenue from any economic rents. These
include stamp duty, payroll tax, fuel excises, and most
importantly, company income tax.
The company income tax liability is computed by applying a
30 per cent tax rate to taxable company income determined
according to the provisions of the Income Tax Assessment Act
1997.
The majority of the income tax provisions embodied in the
Income Tax Assessment Act 1997 (as amended) are applicable to
taxable income irrespective of its origin. There are, however, a
number of special taxation arrangements in the company income
tax system that have the effect of reducing the income taxes that
companies in the minerals sector pay relative to companies in
other sectors.
These special arrangements have the objective of encouraging
mining companies to undertake more exploration, and in some
cases development, than they would otherwise have carried out.
The capital-intensive and upfront nature of exploration and
development outlays, together with the risks inherent in the
industry, have traditionally been recognised as the reasons why
the minerals sector should receive more favourable treatment.
Deductibility of exploration expenditures
Division 40 of the Income Tax Assessment Act 1997 contains the
provisions that are relevant to mineral (including petroleum)
exploration and quarrying and mining activities. Subdivision
40-H allows immediate deductibility for exploration and
prospecting expenditure. The definition of exploration or
prospecting is very wide and includes (in section 40.730):
• For minerals generally:
• geological mapping, geophysical surveys, systematic
search for areas containing minerals or quarry materials,
and the search by drilling or other means for minerals or
materials within those areas; and
• the search for ore within, or near, an orebody or search
for quarry materials by drives, shafts, cross-cuts, winzes,
rises and drilling.
• For petroleum particularly:
• geological, geophysical and geochemical surveys; and
• exploration drilling and appraisal drilling.
• Feasibility studies to evaluate the economic feasibility of
mining minerals (including petroleum) once they have been
discovered.
• Obtaining mining, quarrying or prospecting information
associated with the search for, and evaluation of, areas
containing minerals or quarry materials.
Subdivision 40-H also allows immediate deduction for
expenditure on mining site rehabilitation (section 40.735.) and
immediate deduction for environmental protection activities
(section 40.755). Additional deductions are available as a result
of Tax Ruling 95/36. In particular the removal of overburden in
mining operations is a deductible expense.
In strict accounting terms, exploration expenses are directed
towards the accumulation of knowledge about the geological
characteristics of a specific area and therefore represent the
acquisition of (intellectual) capital. In the case of other
industries, the tax authorities would not normally allow this type
of expenditure as a current deduction in the calculation of
taxable income in the year in which it has been incurred, but
would require that it be depreciated or amortised over time. Yet,
as shown above, for mining companies, the Australian
Government does allow the deduction of exploration expenses in
the year in which they are incurred.
Australian Mineral Economics

Depreciation of capital expenditures
Subdivision 40-I-deals with capital expenditure that is deductible
over time. Capital expenditures on mining incurred after 30 June
2001, is deductible as a project amount through a project pool
over ten years the lifetime of the project, whichever is least.
Mining capital expenditure is capital expenditure incurred on:
• carrying out eligible mining or quarrying operations;
• site preparation;
• necessary buildings or improvements;
• provision of water, light or power to the site of those
operations;
• building used directly for operating or maintaining treatment
plant;
• buildings and improvements for storing minerals or quarry
materials for treatment; and
• housing and welfare – except for quarrying operations.
Transport capital expenditure is depreciable over ten years. It
includes capital expenditure on:
• a railway, road, pipeline, port or other facility used
principally for mining or quarrying transport;
• obtaining a right to construct or install such a facility;
• compensation for damage for constructing or installing such
a facility;
• earthworks, bridges, tunnels or cuttings; and
• contributions made in carrying on business to someone else’s
expenditure on the above items.
There may, therefore, be significant differences between
shorter asset lives used to determine income tax payable and the
longer asset lives used, according to accounting standards, to
determine the annual profit in the financial statements in a
company’s annual report. Where shorter asset lives are allowed
in the determination of company tax liabilities, the result is that
some tax is deferred.
The Australian depreciation provisions for mining may not be
attractive compared to some of the other fiscal regimes with
which Australia competes for investment in the industry. Recent
changes have seen the removal of accelerated depreciation for
mining activities and a move to establish common depreciation
principles (the Uniform Capital Allowance system) across all
sectors of the economy.
Current taxation laws discriminate in favour of large integrated
companies compared with pure explorers. The former can write
off their exploration and prospecting expenditure in the year in
which they incur it against taxable income generated by a related
company, thus accelerating cash flows. A related company is one
that either owns or is owned by the exploration company or
which is co-owned by a common parent company. By contrast, a
pure explorer may lack any taxable income against which to
write off its exploration expenditure, and can only capitalise it
and, in effect, carry forward the relevant loss until the company
generates some taxable income or is sold. This may take many
years, during which cash flow is delayed and, under inflationary
conditions, the tax-shield effect of exploration expenditure is
gradually eroded.
It is for the foregoing reasons that small and middle-size
exploration companies have lobbied strongly but unsuccessfully
for the introduction of a ‘flow-through share scheme’ whereby
exploration expenditure would become a legitimate tax
deduction in the hands of shareholder subscribing equity funds to
the company. The introduction of such a scheme in Canada has
resulted in a marked revival of exploration investment in that
country (Hall, 2003).
Australian Mineral Economics
CHAPTER 15: MINERAL TAXATION AND ROYALTIES
Other issues
It is possible to rationalise the special tax treatment of
exploration using the concept of positive externalities. When a
company undertakes exploration activity at its own cost:
• it adds to geological knowledge by doing so, and
• that knowledge is available to all other mineral explorers.
Exploration therefore creates a spillover effect or positive
externality. Other exploration companies will be able to use that
geological knowledge in adjoining areas and conduct exploration
at a lower cost than if the initial exploration had not been
undertaken. The activity of one company therefore reduces costs
for another, but the company that incurred the initial costs is not
able to benefit from this information spillover because it does not
have property rights to the information.
For this to be true it is, however, important that the
geoscientific information generated by the mineral exploration
industry be properly collated, managed and widely and freely
distributed by the relevant state institutions, generally the
geological surveys.
In the light of this mismatch between costs incurred by the
initial exploration and benefits generated for the initial explorer
and all other explorers, the amount of exploration without some
form of subsidy would be less than what was socially desirable.
The special tax treatment of exploration expenses provides a
benefit to exploration companies that reflects the benefits they
provide to the exploration sector as a whole when they carry out
exploration activities.
Another area of federal taxation that bears a strong influence
on the viability of mining projects is the treatment of hedging
gains and losses on forward sales. In recent years, many
commodity markets have tended to be in contango rather than in
backwardation. Recall from Chapter 7 that contango is a state of
affairs whereby the forward price of a commodity is higher in
succeeding months than in the nearest delivery month.
Backwardation is the opposite situation.
With contango in place, mining companies selling forward, part
or the whole of their production, may realise higher prices than if
they sold on the spot market. They derive this benefit, however, by
foregoing the benefit that they would have derived if the spot price
on the delivery date were to exceed the corresponding forward
price. Aside from neutralising market risk, however, hedging has
been used as a funding mechanism for mining operations.
Providers of project finance may insist on part of the first few
years’ production to be sold forward to reduce potential revenue
volatility while their loans are outstanding and therefore at risk.
The Australian Taxation Office draws a clear distinction between
companies or individual making use of forward or future sales for
speculative purposes and genuine mining companies using a
schedule of successive forward contracts as an insurance and
funding mechanism. In the latter cases, companies are allowed to
roll contracts over for a specified and clearly planned period of
time without incurring a tax liability on the gain realised at each
rollover. By contrast, in the case of speculators, each contract
closure would engender a tax liability.
MINERAL REVENUE POLICIES FOR THE FUTURE
The prevailing situation in Australia at the time of writing is one
of stability. The Commonwealth is committed to the use of the
resource rent approach, which currently applies to offshore
petroleum projects, but it is prepared to be flexible and respond
to industry concerns (Commonwealth Government, 2005c).
State governments are unwilling to move out of the dominant
specific and ad valorem modes, though they are making them
more effective through the removal of exemptions, and through
better determination of the value base, moving it closer to a net
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value of the minerals, and thus creating a less distorting
approach. There are currently no resource rent-based mineral
(excluding petroleum) royalties in Australia, while the
application of profit-based royalties is an exception.
While the theoretical analysis is fairly unanimous in considering
resource rent-based systems as the most economically efficient
and equitable, there is a question as to why their degree of
acceptance by state governments has been so low.
Given that governments are aware of the underlying economic
theory, there are a number of reasons that may explain their
acceptance of the inefficiency of currently applied systems.
These include:
• Administrative complexity and potential for ambiguity and
litigation inherent in profit and rent-based royalty systems.
These stem from the determination of the rent base on which
the tax is to be applied. Few government instrumentalities are
currently adequately resourced to administer the prevailing
royalty systems, let alone alternative profit- or rent-based
systems. While it may be the case that the addition of
resources to royalty-collecting agencies has the potential for
improving returns, governments have been reluctant to do so.
• Variability in revenue due to the volatility of commodity
prices over time.
• Delays in revenue flows due to the ability to carry forward
and increase early project losses.
• Complexity and cost of compliance on both industry and
government. There is an obvious difference between the cost
of administering a specific royalty based on weight alone and
auditing the allowable deductions of exploration and
development projects of an oil company in Australia. Only
projects with significant size, unit price for their output and
gross value of production (especially petroleum projects)
may justify high compliance costs.
Nonetheless, small forays have been made with the
introduction in 2000, in Western Australia, of a new hybrid
royalty system for vanadium pentoxide. This featured a net back
approach subject to a minimum 1.5 per cent ad valorem
component. Unfortunately the Windimurra vanadium mine to
which this system applied has since closed down for unrelated
reasons; hence not much has been learned from this experiment.
One might argue that governmental reluctance to move to
profit or resource rent based systems is denying the opportunity
to return rents to the citizens either in the form of lower taxation
in other areas or increased government expenditures. State
governments are also denying themselves the opportunity to use
the rents from the minerals sector to create substitute assets that
could maintain the flow of income into the future, given that
existing income levels are based on a depleting asset base. With
the high levels of foreign ownership in the Australian mining
industry, leaving the rents with the companies seems unlikely to
generate investment that would provide income earning assets for
the citizens of the Australian states from which the rents are
derived. Based on her analysis of the situation in Nauru, Hughes
(2004) suggests that the best approach is to return the rents to the
citizens directly and allow them to make investment decisions.
With respect to the company income tax, the trend will
probably be towards further harmonisation of the conditions
relating to mining with those applying to all other industries.
NOTE ON REFERENCES
The oil price increases of the 1970s and early 1980s, as well as
the concern over the apparently limited supply of metallic
mineral resources provoked an interest in the economic rents that
were or would be accruing in the face of apparent scarcity. The
184
result was a major contribution to the economics literature of the
time, which focused on the meaning of economic rent and the
means by which governments might share in economic rents. A
number of issues were settled in the academic literature of that
time, such as the theoretical preference for rent-based mineral
revenue systems over production- or value-based systems.
Since that time, the literature has been largely confined to
tidying up the earlier analysis with no great innovations or
perspectives coming to the fore. This pattern in the literature was
mirrored in the actions taken by governments in the same period.
There were major government inquiries and many legislative
innovations. By the end of the 20th century, this process had
halted, with established positions being maintained and little
external pressure for change. Only in those countries where
previously there was no attempt to capture economic rents, for
example in Chile and Peru, is there a current interest in the
design of rent-collecting systems.
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Alberta Heritage Fund, 2005. [Online] <http://www.finance.gov.ab.ca/
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Bradley, P G, 1986. Report of the Mineral Revenues Inquiry, Volumes 1
and 2 (Western Australian Government: Perth).
Calzada, M, 2000. State government mining royalties: requited taxes or
duties of excise? Murdoch University Electronic Journal of Law,
7(3). [online]. Available from: <http://www.murdoch.edu.au/elaw/
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Committee for the Review of Commonwealth-State Funding, 2002. Review
of Commonwealth-State funding, the final report [online]. From:
<http://www.reviewcommstatefunding.com.au/library/finalrep.pdf>.
Commonwealth Government, 2004. Cash bidding system in Australia,
[online]. Available from: <http://www.industry.gov.au/assets/
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Commonwealth Government, 2005a. Details of the petroleum resource
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Commonwealth Grants Commission, 2003. Mining revenue,
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R2004/daps/DAP%202003_13%20Mining%20Revenue.pdf>. Date
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Crommelin, M, 1996. State agreements: Australian trends and
experience, Australian Mining and Petroleum Law Association
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Denolder, T, 2000. Terms of the deal: native title agreements, Australian
Mining and Petroleum Law Association Yearbook, pp 537-556
(AMPLA Limited: Melbourne).
Garnaut, R and Clunies-Ross, A, 1983. Taxation of Mineral Rents,
(Clarendon Press: Oxford).
Government Petroleum Fund, 2005. [Online]. Available from:
<http://www.norges-bank.no/english/petroleum_fund/reports/1999/3.
html>. Date accessed: 8 May 2006.
Hall, B, 2003. Canadian incentives for mineral exploration and mining,
[online]. Available from: <http://www.ausimm.com/policy/canadian
03.pdf>. Date accessed: 8 May 2006.
Hansard, 2005. Legislative Assembly, Thursday, 2 June 2005, p 2712.
Hartwick, J M, 1977. International equity and the investing of rents from
exhaustible resources, American Economic Review, 66(5):972-974.
Hematite Petroleum Pty Ltd v Victoria, 1983. 151 CLR 599.
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Hotelling, H, 1931. The economics of exhaustible resources, Journal of
Political Economy, 392:137-175.
Hughes, H, 2004. From riches to rags: what are Nauru’s options and how
can Australia help? Issue Analysis, Centre for Independent Studies,
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Hughes, H and Singh, S, 1978. Economic rent: Incidence in selected
metals and minerals, Resources Policy, 4(2):135-140.
New South Wales Government, 2005. New South Wales royalty system,
[online]. Available from: <http://www.dpi.nsw.gov.au/minerals>.
Date accessed: 8 May 2006.
Northern Territory Government, 2005. Overview of the mineral royalty
scheme [online]. Available from: <http://www.nt.gov.au/ntt/revenue/
overmra.shtml>. Date accessed: 8 May 2006.
O’Hare, C W, 1971. A history of mining law in Australia, The Australian
Law Journal, 45(June):281-293.
Queensland Government, 2003. Mining royalties [online]. Available from:
<http://www.nrm.qld.gov.au/mines/royalties/mining_royalties.html>
Date accessed: 8 May 2006.
Queensland Government, 2005. Action policy no 68 [online]. Available
from: <http://www.nrm.qld.gov.au/about/policy/documents/468/
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Smith, B, 1999. The impossibility of a neutral resource rent tax, Working
Papers in Economics and Econometrics, No 380 (Faculty of
Economics and Commerce, Research School of Social Sciences,
Australian National University: Canberra).
Solow, R W, 1974. The economics of resources or the resources of
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South Australian Government, 2004. The Schedule, Section 32, Roxby
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MRT_ABOUT_MRT/MRT_ANNUAL_REVIEWS/AR2003_2004_
COLOUR.PDF>. Date accessed: 8 June 2006.
Tasmanian Government, 2005a. Tasmanian royalty regime [online].
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Tasmanian Government, 2005b. The Hellyer Mine Agreement Ratification
Act 1987 (No 67 of 1987) [online]. Available from: <http://www.
thelaw.tas.gov.au>. Date accessed: 8 June 2006.
The Australian, 2005a. Diamond deal gives blacks $50m, The Australian,
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The Australian, 2005b. BHP to follow Rio on higher ore royalties, The
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The Australian, 2005c. Cut royalties, miner pleads, The Australian, 13 June
2005.
Tilton, J E, 2003. On Borrowed Time? Assessing the Threat of Mineral
Depletion (Resources for the Future: Washington DC).
Victorian Government, 2005. Victorian royalty regime [online]. Available
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CHAPTER 15: MINERAL TAXATION AND ROYALTIES
FURTHER READING
Argyle, R E S, 1984. Resource rent tax-the Commonwealth’s proposals,
Australian Mining and Petroleum Law Association Yearbook,
pp 296-309 (AMPLA Limited: Melbourne).
Bambrick, S, 1979. Australian Minerals and Energy Policy (Australian
National University Press: Canberra).
Bartlett, R H, 2004. Native Title in Australia, second edition (LexisNexis
Butterworth: Sydney).
Church, A M, 1985. Natural Resource Taxation Policies (Centre for
Research on Federal Financial Relations: Canberra).
Commonwealth of Australia, 1900. The Australian Constitution [online].
Available from: <http://www.aph.gov.au/senate/general/constitution>
Date accessed 8 May 2006.
Flint, D, 1982. Resource taxation and the Mining Royalty Act 1982 (NT),
Australian Tax Review, 11:202-216.
Fraser, R, 1993. On the neutrality of the resource rent tax, Economic
Record, 69(204):56-60.
Fraser, R, 1998. Lease allocation systems, risk aversion, and the resource
rent tax, Australian Journal of Agricultural and Resource Economics,
42(2):115-130.
Fraser, R, 1999a. An analysis of the relationship between uncertainty-
reducing exploration and resource taxation, Resources Policy,
24(4):199-205.
Fraser, R, 1999b. An analysis of the Western Australian gold royalty,
Australian Journal of Agricultural and Resource Economics,
43(1):35-50.
Fraser, R, 1999c. The state of resource taxation in Australia: An
inexcusable folly for the nation? The Australian Journal of
Agricultural and Resource Economics, 43(3):259-278.
Fraser, R and Kingwell, R, 1997. Can expected tax revenue be increased
by an investment – preserving switch from ad valorem royalties to a
resource rent tax?, Resources Policy, 23(3):103-108.
Garnaut, R and Clunies-Ross, A, 1975. Uncertainty, risk aversion, and the
taxing of natural resource projects, Economic Journal, 85(2):272-287.
Garnaut, R and Clunies-Ross, A, 1979. The neutrality of the resource rent
tax, Economic Record, 55(150):193-201.
Hogan, I, 2003. Australia’s petroleum resource rent tax: An economic
assessment of fiscal settings, ABARE Report 03.1 (Department of
Industry, Tourism and Resources: Canberra).
Hogan, I and Donaldson, K, 2000. Mineral royalties – net economic
benefits of mining to Australia, Australian Commodities, (7):519-531.
Leyland, P, 1978. Optimal risk sharing and the leasing of natural
resources, with application to oil and gas leasing on the OCS,
Quarterly Journal of Economics, 92(2):413-438.
Lloyd, P J, 1984. Mineral Economics in Australia (George Allen and
Unwin: Sydney).
Manley, K, 1987. Federalism and the taxation of crude oil in Western
Australia: a case study of the Barrow Island resource rent royalty,
unpublished economics Honours dissertation, Murdoch University.
McCarthy, S B, 2000. Comments on a critical evaluation of the Petroleum
(Submerged Lands) Act, Australian Mining and Petroleum Law
Yearbook, pp 125-137 (AMPLA Limited: Melbourne).
Northern Territory Department of Mines and Energy, 1981. Green Paper
on Mining Royalty Policy for the Northern Territory, Darwin.
Parker, K H, 1984. Implications of the pipeline case for state resource
revenue, Australian Mining and Petroleum Law Yearbook, pp 1-21
(AMPLA Limited: Melbourne).
Pett, R, 1980. Taxation of the Australian Minerals Industry, unpublished
economics Honours dissertation, Murdoch University.
Ricardo, D, 1821. On the principles of political economy and taxation,
Chapter 2 [online]. Available from: <http://econlib.org/library/Ricardo/
ricP1a.html>. Date accessed: 8 May 2006.
Stevenson, G, 1976. Mineral Resources and Australian Federalism,
(Centre for Research on Federal Financial Relations: Canberra).
Trevison, S, 1995. North Flinders Mine Ltd vs Neil Conn as
under-treasurer of the Northern Territory Treasury, Australian Mining
and Petroleum Law Yearbook, pp 508-519 (AMPLA Limited:
Melbourne).
185

Mining, Sustainability and Sustainable Development
Roderick Eggert
Introduction
Sustainability and Sustainable Development
Mining and Environmental Sustainability
Mining and Economic Sustainability
Mining and Social Justice
Public Policy: Principles and Concepts
Putting Sustainability and Sustainable Development into Practice in Mining
Final Thoughts
Appendix A – The Mining, Minerals and Sustainable Development Project
Appendix B – Summary Findings of the Extractive Industries Review
Appendix C – Ten Principles of the Global Compact
INTRODUCTION
Mining inevitably affects the natural environment and local
communities. The economic benefits of mining sometimes come
with significant environmental and social costs to mining
communities and regions. Balancing the economic,
environmental, and social benefits and costs of mining is the
focus of the quest for sustainable development in mining.
Popular and professional interest in sustainability and
sustainable development stems from concerns that many current
activities may be unsustainable – that is, that some current
economic activities, including some mines, may result in such
significant environmental and social damage and disruption that
they will leave future generations worse off than the current
generation.
This paper provides an overview of sustainability and
sustainable development as they relate to mining. It begins by
defining the various aspects and dimensions of sustainability and
sustainable development generally. The paper then suggests how
these concepts apply to the mining sector. It concludes by
outlining an appropriate role for government in ensuring that
mining is consistent with sustainability and sustainable
development and by noting several of the more significant efforts
to promote sustainability and sustainable development in mining.
SUSTAINABILITY AND SUSTAINABLE
DEVELOPMENT
The concepts of sustainability and sustainable development mean
different things to different people. Thus they often lead to
discussions that are more bewildering than enlightening.
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CHAPTER 16
Sustainability perhaps is best thought of as a one-dimensional
concept and comes in at least three forms. Environmental
sustainability is a physical goal – sustaining environmental
quality and the stock of natural resources. One can imagine
managing a renewable resource, such as a fishery, in such a way
that the rate of harvest does not exceed the rate of natural
regeneration; thus the stock of the resource is sustained
indefinitely. Or a set of natural resources – such as an ecosystem
with plants, animals, water, soil, air, and so on – could be
managed in such a way that the overall stock of the set of
resources is at least maintained. Still another version of
environmental sustainability involves maintaining air quality or
water quality at some prescribed level (which might be measured
as a maximum allowable rate of pollution emissions into the air
or water). Maintaining biodiversity is an important issue is this
form of sustainability. Environmental sustainability emphasises
maintaining the ability of the natural environment to provide
life-sustaining and aesthetic services, such as clean air and water,
the energy and mineral resources necessary for the human
economy, and so on. It also emphasises the belief that the natural
environment should be preserved for its own sake, independent
of how human beings use the natural environment for their
activities.
Economic sustainability emphasises sustaining improvements
in human living standards or human wellbeing. Narrow measures
of economic sustainability are the level and growth rate for a
nation’s gross domestic product per capita, the estimated
per-person value of a nation’s output of goods and services,
which in turn is equivalent to per-capita income. Broader
measures of economic sustainability include indexes that attempt
to capture other (less purely economic) aspects of human living
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standards, such as literacy rates, life expectancy, income
distribution, and other indicators of economic development. One
such index is the Human Development Index of the United
Nations Development Programme (http://hdr.undp.org/statistics).
Another conceptual measure of economic sustainability is what
economists call the capital stock – the total value of inputs to the
production of goods and services, including natural resources,
labour, buildings, equipment and processes. The larger the
capital stock, here defined broadly to include natural resources
and environmental quality, the larger the capacity of an economy
to generate income and economic wellbeing.
Social and cultural sustainability, a third form of
sustainability, emphasises social justice. This form of
sustainability focuses primarily on the search for fairness in the
distribution of benefits and burdens associated with economic
activities. It also focuses on the process through which decisions
are made about whether and how new commercial activities
occur. The distribution of the benefits and costs of commercial
activities is rarely equal across society. For example, a large new
commercial development may be beneficial for a national or
provincial economy overall and yet leave the local community or
indigenous peoples in the vicinity of the new investment entirely
indifferent (and even arguably worse off) than before the new
investment. This raises questions such as what level and form of
compensation, if any, is appropriate for local communities or
indigenous peoples to receive for the social disruption, loss of
cultural identity, or environmental damage caused by the new
commercial activity? Also how should the affected local
communities or indigenous peoples share in the net benefits of
the new commercial activity?
Sustainable development, in contrast to sustainability, is
inherently and explicitly multidimensional. It can be considered
as the simultaneous pursuit of sustained or enhanced:
environmental quality, economic growth, and social justice. In
other words, sustainable development represents economic
development that is consistent with society’s preferences for
environmental quality and social justice. There is no single
measure of progress toward sustainable development; rather
there are various indicators of progress in the three different
realms of sustainability. Progress toward sustainable
development involves striving for all three types of sustainability
simultaneously – inevitably leading both to conflict among
competing environmental, economic, and social goals and to the
search for common ground. While progress toward the three
forms of sustainability individually can be (relatively easily)
measured, progress toward sustainable development is more
difficult to measure and requires much attention be paid to the
institutions and processes through which decisions are made.
Whether one is concerned about sustainability or sustainable
development, there are several important issues that cut across all
versions of these concepts. The first is the issue of scale. Are we
concerned about the sustainability or sustainable development of
a local community? A subnational state or province? A nation?
Some other scale of focus independent of human-imposed
political boundaries, such as a transnational ecosystem? Or the
world as a whole?
A second cross-cutting issue is the magnitude of human
activity relative to the carrying capacity of the natural
environment to support this activity. Most people would agree
that the lower the level of human activity, the greater the ability
of the natural environment to absorb environmental degradation
and to regenerate itself. Where people disagree, however, is how
great the current level of human activities is relative to carrying
capacity.
A third cross-cutting issue is how to be fair both to the
current generation and to future generations. For example,
consider a new commercial activity that raises the incomes and
helps improve the overall wellbeing today of impoverished
people in a poor country. Further imagine that this commercial
188
activity also leads to environmental damage that could over a
period of decades lead to possible increased sickness in some
people and even a small number of deaths. Or, to be less
dramatic, the commercial activity leads to the reduction of scenic
vistas or elimination of pristine wilderness, again over a period
of decades. What is the most appropriate way to balance the
economic benefits received today with the possible future
damages to the human health or the environment?
Economists typically use the process of discounting to balance
benefits and costs that occur over an extended period of time. All
current and future benefits and costs – economic, as well as
social and environmental – are identified and estimated. All
future benefits and costs are then discounted at a rate that
represents society’s rate of time preference. A dollar of benefits
or costs today is worth more than a future dollar – for two
reasons. The first is simply that humans are impatient and thus
give higher values to current rather than future benefits and costs.
The second, and perhaps more significant, justification for
discounting is based on opportunity costs or capital growth. That
is, by waiting to receive a benefit in the future, a person foregoes
the opportunity to put money to a productive use today that
grows in value over time. The opportunity for capital growth is
lost. The higher the discount rate, the more valuable the present
is relative to the future. Critics of the first justification of
discounting argue that impatience is inherently unethical and
unfair to future generations. Critics of the second justification
(capital growth) argue that, while discounting may be appropriate
for evaluating commercial investment opportunities with benefits
and costs that largely affect the current generation, discounting is
fundamentally inappropriate for decisions involving future
generations and environmental resources that arguably are
critical to the survival of these future generations. For more
discussion on discounting and how to define what is fair for
future generations, see Portney and Weyant (1999).
This general introduction to sustainability and sustainable
development sets the stage for the next section of the chapter,
which focuses on the implications of sustainability and
sustainable development for mining.
MINING AND ENVIRONMENTAL SUSTAINABILITY
Environmental resources include the stock of natural resources as
well as environmental quality. Environmental sustainability,
therefore, has two important dimensions for mining.
The first is the physical sustainability of mineral
production. At the scale of an individual mine, mining is
inherently unsustainable. A mineral deposit contains a finite
amount of mineral ore, and mining eventually will deplete this
ore. Nevertheless, mineral production is more sustainable than it
appears initially. Rarely is the full extent of a mineral deposit
known at the time mining commences. Mining companies
routinely extend mine lives by exploring for and developing
additional reserves at existing mines. At a broader scale, mining
companies extend mineral production and support
ever-increasing rates of mineral consumption by discovering and
developing previously unknown mineral deposits. Improved
technologies (for exploration, mining and mineral processing)
also serve to sustain mineral production by making it technically
and commercially feasible to mine mineral resources that
previously were technically or commercially infeasible to mine.
In a broader sense, recycling sustains the benefits of mineral use
even if it does not sustain mine production.
The second dimension is the sustainability of environmental
quality, which can be considered the ability of the natural
environment to provide life-supporting and aesthetic services to
humans, plants, and animals. Mining inevitably disturbs the
natural environment. During mineral exploration and mine
development, environmental damage typically is localised and
relatively easy to minimise. Mining and mineral processing,
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 CHAPTER 16: MINING, SUSTAINABILITY AND SUSTAINABLE DEVELOPMENT
however, are associated with more extensive environmental
disturbances, the exact nature and extent of which vary
considerably from mine to mine. Mining disturbs surface land,
typically more so for surface mines than underground mines.
Mining creates solid waste in the forms of overburden, waste
rock and tailings. The volume of solid waste is large because
recoverable metal usually represents only a small weight percent
of the rock moved during mining. Some types of mining create
acid-mine drainage when water interacts with newly exposed
mineralised surfaces of mined rock, affecting water quality,
plants, and animal habitats. Metallurgical processing, such as
smelting and refining, often creates air pollution. After mining
and mineral processing ends, environmental damage can
continue if a site is not rehabilitated; this is especially true for
acid-mine drainage and the aesthetic damage of unsightly
landscapes. Sustaining an appropriate level of environmental
quality has both short-term and long-term aspects. In the short
term, the appropriate level of environmental quality should be
determined by finding the appropriate balance between the
benefits and costs of environmental protection. Over the longer
term, technical innovations in mining and mineral processing
hold forth the possibility of reducing both production and
environmental costs.
MINING AND ECONOMIC SUSTAINABILITY
The degree to which mining contributes to the creation and
sustainability of economic benefits in a community, region, or
nation depends on three factors, as suggested by Tilton (1992).
First, minerals in the ground must be developed; otherwise they
represent a dormant asset. Second, an appropriate portion of the
proceeds from mining must be invested in activities that will
sustain the economic benefits created by mining once mining
ceases. Third, an economy (whether local, regional, or national)
must avoid the potentially negative macroeconomic and political
consequences of mineral development. Let us consider each of
these three factors in turn.
Whether the private sector develops a nation’s or a region’s
mineral wealth depends on a variety of factors, including
importantly the nation’s or region’s institutional framework.
Some of this framework is common to all commercial activities
in a particular political jurisdiction – the rules, regulations,
customs, government institutions, and risk perceptions that
define the jurisdiction’s legal, fiscal, and business environment.
See the World Bank’s World Development Report 2002 for a
comprehensive examination of how institutions influence
markets (World Bank, 2002). More narrowly, an important part
of a jurisdiction’s institutional framework is specific to the
mining sector. Public policies influence the availability of basic
geologic information upon which private investors make
decisions about mineral prospecting and exploration. Most
economists believe that the private sector alone will under-invest
in the collection of basic geologic information, either because it
is more risk averse than society as a whole toward risky ventures
or because the benefits of collecting basic information are
difficult to appropriate or capture fully. Sometimes governments
directly fund the provision of basic geologic information through
geological surveys. At other times, governments subsidise the
private collection and dissemination of this type of information.
Mineral policies also help define an institutional framework
for mining. What constitutes mineral policy varies considerably
from place to place. Some political jurisdictions have single
comprehensive documents with all or most relevant rules. In
other cases, mineral policy simply represents the overall set of
rules governing mining as set forth in separate policies governing
land use, taxes, environmental regulation, and so on. In any case,
mineral policy can be thought of as legislation and rules
governing:
Australian Mineral Economics
1. ownership of mineral resources and mining operations;
2. land access and security of tenure for mineral exploration
and mine development, including preproduction approvals
and the role and rights of local communities in the
mine-development process;
3. mineral royalties and taxation; and
4. environmental protection, including post-mining requirements
for closure and rehabilitation.
The second requirement for economic sustainability is that the
economic benefits of mining be made permanent through
investment in assets that will continue to generate economic
wellbeing as mining declines or ceases. In other words, the
depleting mineral asset in the ground needs to be replaced with a
sustainable, man-made asset. These substitute man-made assets
can take a variety of forms. At the scale of a community or
region, investments might be made in other types of business for
which the community or region has a competitive advantage. Or
rather than investing in a specific line of business, local or
national governments might invest in social infrastructure that
facilitates economic activities generally, including education,
health care, transportation, water, electricity, and technological
research and development.
The third requirement for economic sustainability is that a
region, or nation, avoids the potentially negative macroeconomic
and political consequences of mineral development. These
potential consequences can take a variety of forms. One form
involves income instability (boom and bust) and associated
problems resulting from unstable mineral prices and arguably
excessive dependence on mineral production. Another form is
the adjustment problem associated with a booming natural
resource sector. Sometimes called the Dutch disease, this
problem leads to a shrinking of the non-boom sectors of an
economy (often agriculture or manufacturing) even as overall
national output and income increase. Still another potential
problem involves incentives. The argument is that the presence of
surplus revenues or rents from mineral production invites
competition among special interest groups over sharing of the
surpluses, diverting efforts away from creating the surpluses in
the first place. An aspect of this phenomenon is the seeming
propensity for some mineral-dependent economies to be corrupt.
Finally, mineral dependence may encourage the illusion of
plenty, leading to irresponsible economic and political decisions,
too much consumption, and too little investment. Although there
is considerable ongoing debate about the seriousness and
inevitability of these potentially negative consequences of
mineral dependence, the predominant view is that they are
avoidable with appropriate public policies.
MINING AND SOCIAL JUSTICE
Social and cultural sustainability, the quest for social justice, is
largely a moral and ethical issue. It is much more difficult to
define and measure than environmental and economic
sustainability because it requires agreement on what is fair, just,
and ethical. Although there are considerable disagreements about
how to define environmental and economic sustainability, at least
these types of sustainability lend themselves readily to
quantification (eg using a physical measure of environmental
degradation to measure environmental quality, using monetary
values of income to estimate net economic benefits).
Much of the discussion and disagreement around this form of
sustainability involves distribution – that is, what is the fair
distribution of benefits and costs associated with mining. Many
of the benefits and costs of a mine are ‘private’ in the sense that a
mining company incurs costs from mining (construction, labour,
management, raw materials, etc) in exchange for which it
receives revenues from the sale of minerals. Other benefits and
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costs, however, are ‘external’ to a mining company in the sense
that it does not directly receive the benefit or incur the cost.
External benefits can include: regional economic development
coming in the form of, for example, local purchase of food and
other inputs by the mine and local spending of mining wages on
food, entertainment, furniture, clothing, and other goods and
services; and improved educational and health-care systems from
spending on schools and hospitals. External costs can include:
environmental degradation; social problems often accompanying
frontier development such as increased rates of alcoholism,
prostitution, and teenage delinquency; and cultural disruption
when indigenous peoples are confronted with mine development.
A major source of contention is the distribution of mining’s
benefits and costs between national governments and local
communities. Many of the benefits of mineral development go to
mining companies (as revenues) and to national governments (as
taxes and royalties). Many of the costs are external and borne by
local communities in the form of environmental degradation and
costs of social disruption. To be sure, local communities benefit
from mining. But the critical issues are:
• Are local communities appropriately compensated for the
external costs they bear from mining?
• Do local communities receive an appropriate portion of the
net benefits of mining, relative to mining companies and
national governments?
It is easy to say that local communities should be compensated
for the external costs that they bear. This begs the question,
however, of how exactly to quantify and value the magnitude of
these external costs and how to design institutions, policies, and
regulations to facilitate appropriate compensation. Nevertheless,
the concept of compensation for external cost or damage is not
controversial, even if compensation mechanisms are difficult to
establish.
The same cannot be said, however, about the second question –
defining and ensuring the appropriate distribution of mining’s net
benefits. Eggert (2004), drawing on Young (1994), writes that
achieving equitable distributions of mining surpluses is promoted
by institutional arrangements that answer the following
questions:
• What are the eligibility criteria? Who is eligible to share in
the surpluses of mining and on what basis?
• What determines the relative priority among several eligible
parties? Contributions to the project, such as financial capital
or land? Need, such as when the mining region has higher
poverty rates than the nation as whole? Whether an entity
(such as a local community) receives direct compensation for
environmental or social costs of mineral development or,
alternatively, would rather share in the surpluses?
• What are the relevant precedents? Are there existing
allocation schemes for similar circumstances elsewhere that
might form the basis for a new scheme?
• How should competing principles and criteria be reconciled?
Many allocation schemes incorporate more than one
principle. For example, surpluses might be allocated both
according to need (eg elimination of poverty) and according
to contribution to the project. If the overall surplus is large,
there may not be any conflict between the competing
principles. But if the surplus is small, which principle takes
priority?
• What incentives does a rule or allocation scheme create? For
example, what effect might an allocation scheme have on
mineral exploration if it awards a larger share of surpluses to
local communities than to a mining company? Or conversely,
what effect does an allocation scheme have on community
support for mining if it awards almost all surpluses to a
mining company?
190
Neither mining companies nor local communities should
expect a simple set of rules or a specific allocation scheme to be
viewed as equitable in all circumstances. Rather, most
approaches to achieving equitable outcomes focus on a process
that involves all interested parties to mineral development. Not
only does a mining project need to be economically (or
commercially) and environmentally feasible, it needs to be
socially feasible as well.
PUBLIC POLICY: PRINCIPLES AND CONCEPTS
Governments – whether local, regional, or national – play a
critical role in defining how a society balances the
environmental, economic, and social and cultural goals of the
various forms of sustainability and sustainable development.
Without a philosophy of government, it is almost impossible not
to become lost in the thicket of issues under the umbrella of
sustainability and sustainable development.
One starting point for this philosophy of government in a
market economy argues that governments need to find the right
balance of government and private activities such that the
political unit (local community, state or province, or nation)
satisfies five conditions (World Bank, 1997):
Condition #1 A foundation of law and property rights
Condition #2 A non-distortionary policy environment, including
macroeconomic stability
Condition #3 Investment in people and infrastructure
Condition #4 Protection of the vulnerable
Condition #5 Protection of the environment
Most economists, in turn, believe that governments should
focus their efforts on the following types of activities in defining
government’s role in meeting each condition:
• Facilitating market activities by establishing and maintaining
well-defined property rights and a money and banking
system (see condition 1).
• Promoting economic efficiency by intervening in situations in
which markets by themselves do not function well. Such
situations include: lack of sufficient competition, providing
the economic basis for antitrust policy; provision of public
goods, which typically will be under-provided by the private
sector alone, including national defence, education, and
various types of infrastructure (see condition 4); correction of
negative externalities or spillover effects, such as
environmental pollution (see condition 5).
• Promoting equity (or fairness) in the distribution of income
and wealth and of the benefits and costs of human activities
(see condition 4).
How do these general principles relate and apply to public
policy toward mining, sustainability, and sustainable
development? It is useful to organise the various policy issues
around four aspects of mineral development.
Firstly, government plays an important role in the creation of
mineral wealth (following from the earlier discussion in this
paper on mining and economic sustainability). Mineral wealth is
created when there is sufficient knowledge of minerals in the
ground for someone to purchase exploration, development, or
mining rights, leading ultimately to mining. Government’s role
here is primarily to facilitate market activities. Most of this
facilitating role involves the legal and regulatory framework
governing mineral exploration, mine development, and mining.
Important aspects of this framework include rules governing:
ownership of mineral resources in the ground and of ownership
of mineral-production facilities; collection and dissemination of
basic geologic information, including the roles of government
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geological surveys; land access and security of tenure; and
mineral royalties and taxation. The material in Chapters 13 to 15
in this volume covers many of these issues in further detail.
Secondly, government plays an important role in ensuring
that mineral development occurs in an economically efficient
manner – that is, not simply efficient in a technical or
engineering sense but also consistent with society’s preferences
for environmental quality and social/cultural values. In terms of
the list of microeconomic roles for government (above), the issue
primarily is identifying and dealing with the potential negative
externalities of mineral development, which in turn relate to
mining and both environmental and social sustainability
(introduced earlier). Externalities can be thought of as spillover
effects on third parties that might not be sufficiently considered
by private entities involved in decision making about mining, at
least not without the involvement of government. Another way to
view negative externalities is as unpaid costs. In this view, public
policy plays an important role in making sure that these costs
ultimately are paid (which might come in the form of
compensation to those parties negatively affected).
Environmental damage and the social disruptions that sometimes
accompany mining are possible negative externalities.
Developing public policies and procedures ensuring that these
potential externalities are sufficiently considered is not simple
and straightforward. At a conceptual level, one can think of
project approval as depending on the requirement that expected
net social benefits from a project are positive. Net social benefits
include the private revenues and costs that a private investor
would consider in assessing commercial feasibility, augmented to
include any positive and negative external benefits important to
society at large. (Positive external benefits might include
spillover regional economic activity, such as local purchase of
mining inputs, stimulated by mining.)
In practice, at the level of a single mining project, the critical
policy issues are: Who decides whether proposed mineral
development occurs? On what basis? Through what process? One
could imagine two basic models for decision-making. One model
would require that each mining project undergo a separate and
public process, on a stand-alone basis, through which social
preferences were elicited and after which a decision would be
made on whether to permit mine development. At the other
extreme, the second model would establish objective and
transparent rules and criteria for permitting and other
preproduction approvals for environmental compliance, water
availability and quality, activities to offset potentially negative
social consequences of mining (eg increased rates of divorce and
alcoholism), and so on – in other words a ‘checklist’ of
requirements necessary for approval of mine development. After a
mining project satisfied the checklist, government automatically
would give approval to the mining project. In practice, most
political jurisdictions use a combination of the two models,
involving both public participation and a ‘checklist’ of necessary
pre-production activities. Social benefit-cost analyses (described
above) and environmental and social impact assessments are two
types of study that often serve as analytical tools to frame issues
and aid decision making about mineral development.
Thirdly, government plays an important role in ensuring that
the surpluses from mining are distributed fairly among private
mining companies, national governments, local governments and
communities, and other organisations (the quest for social justice
discussed earlier under social and cultural sustainability). Mines
sometimes generate economic surpluses, often called rents, even
after they provide compensation for the negative environmental
and social consequences of mining (or alternatively, undertake
activities to minimise or avoid these consequences). During the
past decade, how these surpluses are distributed has come into
question. As noted earlier, the frequent concern is that local
communities suffer most of the environmental and social costs of
Australian Mineral Economics
mining and yet share inappropriately in mining’s surpluses;
mining companies and national governments, in this perspective,
are seen as unfairly benefiting from mining’s surpluses.
The core of this issue is: defining what is fair. The previous
discussion in this chapter on social justice identified several
practical issues in defining fairness. At a more conceptual level,
the philosophers Aristotle, Jeremy Bentham, and John Rawls –
although not writing about mining in particular – offer three very
different definitions of fairness in the context of distributing
surpluses (see Young, 1994).
The Aristotelian approach would be to distribute surpluses
according to each party’s contribution to the creation of the
surplus (sometime called proportionality). Business partners share
in profits in proportion to the financial contribution they provide to
a project. In the case of mining, putting proportionality into
practice is more difficult. To be sure, those entities providing
funding for the mine deserve to share in the surpluses in
proportion to their financial contributions. But governments can
argue that they are deserving when they provide some of the
infrastructure used by the mine, including roads, electric power,
sanitation facilities, and workers educated at publicly funded
schools and universities. Even more broadly, society as a whole
(including local communities) can claim that a mineral deposit is a
gift of nature and thus belongs to society at large.
The Bentham approach would be to distribute surpluses such
that the distribution created the greatest good for the greatest
number (sometimes called utilitarianism). Although appealing, it
is difficult to know how to put this into practice at a mine. In
whose hands is the greatest good created? In the hands of a
mining company, which might invest in additional mineral
exploration and mine development? In the hands of a local
community, which might invest in schools and hospitals? In the
hands of a national government, which might invest the surpluses
on the highest national needs, including to reduce poverty in
other regions of the nation? In principle, one should be able to
estimate social rates of return for each alternative use of the
surpluses, but again such calculations are difficult to make in
practice.
The Rawls approach would concentrate the surpluses from
mining on the least well-off groups in society. However, his
approach is more complicated than it appears. His theory
recognises that allocation schemes that redistribute resources
from rich to poor may reduce incentives for creating surpluses in
the first place. Thus Rawls seems to argue that priority should go
to those who are least well off in such a way that mining
companies do not, at the same time, lose the incentive to create
surpluses in the first place.
Fourthly, government plays an important role in ensuring that
the benefits of mining are sustained even after a mine closes –
by investing an appropriate portion of the revenues from mining
in sustainable assets so that, in effect, the depletable mineral
asset in the ground is made permanent and converted into a
sustainable asset. This is an important part of mining and
economic sustainability discussed earlier. The idea is akin to a
trust fund that wealthy families sometimes use to pass along their
wealth to their children or to an endowment that universities use
to fund educational activities: save and invest a portion of current
income, spend (or consume) only the income on the investment,
and in so doing sustain the ability of the original investment to
fund spending indefinitely into the future.
With respect to investing a portion of the proceeds from
mining, several issues are important (Hanneson, 2001):
• How much to save and invest? Answering this question
requires identifying the investment goal. Is it to sustain the
current level of wellbeing? Or to sustain growth in the level
of wellbeing? The more ambitious the goal, the higher the
required saving rate. In addition, it is important to consider
the expected rate of return on investments. The higher the
rate of return, the lower the necessary saving rate.
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• By whom? There are several possibilities here. Mining
companies might invest in sustaining mining operations
through mineral exploration and reserve-development
activities. Governments might invest in non-mining assets
that facilitate economic activities and are likely to be
underprovided by the private sector acting along, such as
physical infrastructure (roads, electric power systems),
education, health care, and basic scientific and technological
research. Partnerships involving mining companies,
government, and civil society (non-governmental and
non-company organisations) also are a possibility.
• In what? Should savings be invested in assets that earn a
financial return, such as business enterprises, real estate, and
financial assets like stocks and bonds? Or should savings be
invested in assets with less-visible, harder-to-evaluate, and
broader social returns, such as physical infrastructure,
education, health care, and basic research? There is general
consensus that governments should not invest in commercial
enterprises or target specific industries with their saving. As
Auty and Mikesell (1998) note:
The historical evidence suggests that directly
productive investment to diversify the economy is
best achieved by the private sector (with
subsidies, if any, being minimal) rather than, as
was fashionable in the 1970s, by the public
sector. Only if there are strong externalities, as
with education and infrastructure, can a clear
case by made for public investment.
However, governments also may find it difficult to invest
appropriately in infrastructure, education, health care, and other
public goods precisely because the full social benefits and costs
of these investments are difficult to quantify. The result is that
such projects are open to manipulation by special-interest
groups. The key here is to develop formal mechanisms for
evaluating social projects and including open and public
participation in the evaluation process.
• Where? In the mining community or region? Somewhere else
in the nation? In another country? Hanneson (2001) suggests
that the appropriate location of investment will vary from
situation to situation, depending on: the size of the economy
(the larger the economy, the more likely there are to be
productive investments within the economy); the level of
economic development in the economy (the lower the level,
the larger the potential returns to social infrastructure
investments in the domestic economy but the less developed
financial institutions may be and the lower the capacity to
absorb domestic investment); and the degree of mineral
dependence (the more dependent an economy is on mineral
production, the greater the urgency of domestic investment
that over the longer term will allow the economy to diversify).
There is a fifth aspect of public policy and mineral development:
managing the potentially negative macroeconomic and political
consequences of mining, as noted earlier in this chapter.
PUTTING SUSTAINABILITY AND SUSTAINABLE
DEVELOPMENT INTO PRACTICE IN MINING
Most governments and mining companies have specific efforts
aimed at incorporating aspects of sustainability and sustainable
development into common practice. Many national governments
have policy documents focused at a philosophical – even if not at
an operational – level, on making mining consistent with
sustainability and sustainable development. Likewise, most large
mining companies have annual documents, similar to annual
1. Papers associated with the Australian workshops and expert-group
meetings appear on The AusIMM website (http://www.ausimm.com).
192
reports to shareholders, summarising efforts related to
environmental protection and how they operate in and interact
with local communities.
At a broader, multi-participant level, there have been several
significant efforts aimed at or with implications for mining,
sustainability, and sustainable development. Between 2000 and
2002, a group of multinational mining companies carried out the
global mining initiative (GMI), studying and attempting to
clarify the roles of mining in sustainability and sustainable
development. The GMI had three principal activities. The first
was to commission an independent study of the key issues.
Initiated through the World Business Council on Sustainable
Development and carried out by the International Institute for
Environment and Development, this project was known as the
Mining, Minerals and Sustainable Development Project
(MMSD). The MMSD process, as it came to be known, involved
regional partnerships focusing on specific issues of importance in
southern Africa, South America, Australia, and North America;
23 global workshops and expert-group meetings involving some
700 people from diverse backgrounds; and some 175 pieces of
commissioned research1.
This work culminated in the publication of the book Breaking
New Ground (IIED, 2002), which summarises the work and
presents findings and recommendations in all three dimensions
of sustainability and sustainable development (environmental,
economic, social) with special focus on public policy and
governance. The executive summary of the MMSD Project
identifies nine challenges for the mining sector (see Appendix
A). The second GMI activity was to organise a global conference
in Toronto in May 2002, at which the findings of the MMSD
Project were presented and discussed. The third and arguably
most significant GMI activity was to establish an industry
association to carry on the work investigated by the MMSD
Project; this organisation is the London-based International
Council on Mining and Metals (www.icmm.com).
A recent initiative associated with this third activity has been
the Mineral Council of Australia’s ‘enduring value’ project that
sets out a framework for mining companies operating in
Australia to pursue sustainable development goals – (see
www.minerals.org.au/enduringvalue/enduring_value). By early
2006, 29 companies were signatories to this project.
The Extractive Industries Review, although not strictly speaking
an effort to put sustainable development into practice, resulted in a
number of recommendations that speak to sustainability and
sustainable development. The review assessed the role of the World
Bank in the extractive industries, including the oil, gas, and mining
industries. Commissioned by the World Bank, the review was
carried out by an independent group that facilitated communication
among the various interested parties to the extractive industries
worldwide – governments, non-governmental organisations,
indigenous peoples, local communities, industry, academia, and
labour unions, among others. The review was a response to strong
criticisms of the World Bank’s role in financing and facilitating the
extractive industries. It asked the question, are the extractive
industries consistent with the goals of sustainable development and
poverty alleviation? The World Bank critics argued that the
extractive industries are inconsistent with these goals – that is,
actually often promote unsustainable development and create
poverty. The review was carried out between the middle of 2001
and the end of 2003. A summary of the findings is contained in
Appendix B and available at: http://www.eireview.org. The World
Bank’s response is available at: http://www.worldbank.org/ogmc.
A group of mineral industry professionals convened
international conferences in 2003 and 2005 on Sustainable
Development Indicators in the Minerals Industry
(http://www.sdimi.org). With plans for a third meeting in 2007,
this group aims to develop operational measures or indicators of
progress toward sustainable development in the mining industry.
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 CHAPTER 16: MINING, SUSTAINABILITY AND SUSTAINABLE DEVELOPMENT
Two other initiatives are not aimed directly at mining but
nevertheless have important implications for the mining sector.
The Equator Principles are a voluntary set of guidelines adopted
by a number of banks and financial institutions, committing the
signatories to follow environmental and social guidelines
developed by the World Bank’s International Finance Corporation
(2005) on all development projects with capital costs of US$ 50
million or greater. As of August 2005, 30 large institutions had
adopted the principles, including ABN Amro, Banco de Brasil,
Bank of America, Barclays, Citigroup, Credit Suisse, Dresdner
Bank, ING, J P Morgan Chase, and Royal Bank of Canada. The
Global Compact is an initiative of the United Nations (2005) and
is a voluntary network of business and other organisations
promising to adhere to a set of practices consistent with
appropriate corporate citizenship in the areas of human rights,
labour practices, the environment, and corruption reduction and
prevention. Appendix C summarises the ten principles of The
Global Compact.
FINAL THOUGHTS
Proponents of sustainability and sustainable development aim to
elevate the role that environmental and social considerations play
in decisions about mineral development – that is, that these
considerations should be evaluated alongside more traditional
business and economic considerations.
However, there still is no consensus on exactly what is to be
sustained, for whom, and through what process. Progress requires
both better measures of sustainability and better processes for
eliciting social preferences for how to balance the environmental,
economic, and social benefits and costs of mining. Otherwise,
sustainability and sustainable development will remain popular
slogans without sufficiently practical implications for company
decisions and government policies.
NOTES ON THE LITERATURE
This chapter draws significantly on three earlier papers from the
author (Eggert, 2000, 2001, 2004).
Readers interested in the topics of sustainability and sustainable
development in general should read Our Common Future (World
Commission on Environment and Development, 1987), often
referred to as the Brundtland report and credited with invigorating
and launching popular and professional discussion of sustainable
development (National Research Council, 1999; World Bank,
2003; Pezzey and Toman, 2005).
For more information on how sustainability and sustainable
development relate to mining see: Auty and Mikesell (1998), Otto
and Cordes (2000) and Breaking New Ground (IIED, 2002).
REFERENCES
Auty, R M and Mikesell, R F, 1998. Sustainable Development in Mineral
Economies (Clarendon Press: Oxford).
Eggert, R G, 2000. Sustainable development and the mineral industry,
Chapter 1, in Sustainable Development and the Future of Mineral
Investment (eds: J M Otto and J Cordes) (United Nations
Environment Programme and Metal Mining Agency of Japan).
Eggert, R G, 2001. Mining and Economic Sustainability: National
Economies and Local Communities, monograph commissioned by the
Mining, Minerals and Sustainable Development Project; available on
the CD ROM accompanying Breaking New Ground: Mining, Minerals
and Sustainable Development, 2002 (Earthscan Publications: London).
Eggert, R G, 2004. The mineral economies: performance, potential
problems and policy challenges, in Managing Mineral Wealth, pp 7-48
(United Nations Economic Commission for Africa: Addis Ababa).
Hanneson, R, 2001. Investing for Sustainability: The Management of
Mineral Wealth (Kluwer Academic Publishers: Boston).
International Institute for Environment and Development (IIED), 2002.
Breaking New Ground, Mining, Minerals and Sustainable Development
– The Report of the MMSD Project (Earthscan Publications: London)
[online]. Available from: <http://www.iied.org/mmsd/finalreport>.
Australian Mineral Economics
National Research Council, 1999. Our Common Journey: A Transition
Toward Sustainability (National Academy Press: Washington, DC).
Otto, J M and Cordes, J (eds) 2000. Sustainable Development and the
Future of Mineral Investment (United Nations Environment
Programme and Metal Mining Agency of Japan).
Pezzey, J C V and Toman, M A, 2005. Sustainability and its economic
interpretations, in Scarcity and Growth Revisited: Natural Resources
and the Environment in the New Millennium (eds: R D Simpson, M A
Toman and R U Ayres) (Resources for the Future: Washington DC).
Portney, P R and Weyant, J P (eds) 1999. Discounting and
Intergenerational Equity (Resources for the Future: Washington, DC).
Tilton, J E, 1992. Mineral wealth and economic development: an
overview, in Mineral Wealth and Economic Development (ed: J E
Tilton) (Resources for the Future: Washington, DC).
United Nations, 2005. The global compact [online]. Available from:
<http://www.unglobalcompact.org>. Date accessed: 8 May 2006.
World Bank, 1997. World Development Report 1997: The State in a
Changing World (World Bank and Oxford University Press: Oxford)
[online]. <http://www.worldbank.org>.
World Bank, 2002. World Development Report 2002: Building
Institutions for Markets (World Bank and Oxford University Press:
New York) [online]. <http://www.worldbank.org>.
World Bank, 2003. World Development Report 2003: Sustainable
Development in a Dynamic World (World Bank and Oxford
University Press: New York) [online]. <http://www.worldbank.org>.
World Bank, 2004. Extractive industries review (EIR) [online]. Available
from: <http://www.eireview.org>. Date accessed: 8 May 2006.
World Bank’s International Finance Corporation, 2005. Equator principles
[online]. Available from: <http://www.ifc.org/equatorprinciples>. Date
accessed: 8 May 2006.
World Commission on Environment and Development, 1987. Our
Common Future (Oxford University Press: Oxford).
Young, H P, 1994. Equity: In Theory and Practice (Princeton University
Press: Princeton).
APPENDIX A – THE MINING, MINERALS AND
SUSTAINABLE DEVELOPMENT PROJECT
Nine key challenges (IIED, 2002)
1. Viability of the minerals industry. The minerals industry cannot
contribute to sustainable development if companies don't
survive and succeed. This requires a safe, healthy, educated and
committed workforce; access to capital; a social license to
operate; the ability to attract and maintain good managerial
talent; and the opportunity for a return on investment.
2. The control, use and management of land. Mineral
development is one of a number of often competing land
uses. There is frequently a lack of planning or other
frameworks to balance and manage possible uses. As a
result, there are often problems and disagreement around
issues such as compensation, resettlement, land claims of
indigenous peoples and protected areas.
3. Minerals and economic development. Minerals have the
potential to contribute to poverty alleviation and broader
economic development at the national level. Countries have
realised this with mixed success. For this to be achieved,
appropriate frameworks for the creation and management
of mineral wealth must be in place. Additional challenges
include corruption and determining the balance between
local and national benefits.
4. Local communities and mines. Minerals development can
also bring benefits at the local level. Recent trends towards,
for example, smaller work forces and outsourcing affect
communities adversely. The social upheaval and
inequitable distribution of benefits and costs within
communities can also create social tension. Ensuring that
improved health and education or economic activity will
endure after mines close requires a level of planning that
has too often not been achieved.
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5. Mining, minerals and the environment. Minerals activities
have a significant environmental impact. Managing these
impacts more effectively requires dealing with unresolved
issues of handling immense quantities of waste, developing
ways of internalising the costs of acid drainage, improving
both impact assessment and environmental management
systems and doing effective planning for mine closure.
6. An integrated approach to using minerals. The use of
minerals is essential for modern living. Yet current patterns
of use face a growing number of challenges, ranging from
concerns about efficiency and waste minimisation to the
risks associated with the use of certain minerals.
Companies at different stages in the minerals chain can
benefit from learning to work together exploring further
recycling, reuse and remanufacture of products and
developing integrated programs of product stewardship and
supply chain assurance.
7. Access to information. Access to information is key to
building greater trust and cooperation. The quality of
information and its use, production, flow, accessibility and
credibility affect the interaction of all actors in the sector.
Effective public participation in decision-making requires
information to be publicly available in an accessible form.
8. Artisanal and small-scale mining. Many millions of people
make their living through artisanal and small-scale mining
(ASM). It often provides an important, and sometimes the
only, source of income. This sector is characterised by low
incomes, unsafe working conditions, serious environmental
impacts, exposure to hazardous materials such as mercury
vapours and conflict with larger companies and government.
9. Sector governance: roles, responsibilities and instruments for
change. Sustainable development requires new integrated
systems of governance. Most countries lack the framework for
turning minerals investment into sustainable development:
these need to be developed. Voluntary codes and guidelines,
stakeholder processes and other systems for promoting better
practice in areas where government is unable to exercise an
effective role as regulator are gaining favour to address these
problems. Lenders and other financial institutions can play a
pivotal role in driving better practice.
APPENDIX B – SUMMARY FINDINGS OF THE
EXTRACTIVE INDUSTRIES REVIEW
The Extractive Industries Review finds that the World Bank has a
role to play in the oil, gas and mining sectors, but only if its
activities promote sustainable development and poverty
alleviation, which in turn only can occur if three enabling
conditions are met:
First, pro-poor public and corporate governance, measured by
criteria such as: quality of the rule of law, absence of armed conflict
or of a high risk of such conflict, respect for labour standards and
human rights, recognition of and willingness to protect the rights of
indigenous peoples and government capacity to promote sustainable
development through economic diversification.
Other characteristics of good governance that the World Bank
should promote include:
• transparency of revenue flows;
• disclosure of project documents;
• capacity to manage fluctuating revenues;
• capacity to manage revenues responsibly;
• modern policy and regulatory frameworks; and
• integrated public participation in local and national decision
making.
194
At the local-community level, the World Bank should:
• require companies to obtain free and informed consent from
local communities and other affected parties;
• require revenue sharing with local communities;
• require the use of poverty indicators that are monitored frequently;
• encourage the establishment of public-health goals in all
extractive projects;
• encourage non-governmental organisations to help build
community capacity; and
• encourage companies to set up independent grievance
mechanisms.
Second, stronger environmental and social requirements for
extractive projects, including:
• required integrated environmental and social impact assessments;
• updated and fully implemented natural habitat policy;
• updated and fully implemented resettlement policy;
• revised disclosure policy;
• sector-specific guidance for tailings disposal, waste
management, and use of toxic substances (including an
outright ban on riverine tailings disposal and extreme caution
on submarine tailings disposal);
• guidelines for integrated closure planning;
• guidelines for emergency prevention and response; and
• responses to legacies of the past.
Third, respect for human rights, verified by third parties and
including adoption of the Core Labour Standards of the
International Labour Organization (World Bank, 2004).
APPENDIX C – TEN PRINCIPLES OF THE
GLOBAL COMPACT
Human rights
Principle 1 Businesses should support and respect the protection
of international human rights within their sphere of
influence; and
Principle 2 make sure they are not complicit in human rights abuses.
Labour
Principle 3 Businesses should uphold the freedom of association
and the effective recognition of the right to collective
bargaining;
Principle 4 the elimination of all forms of forced and compulsory
labour;
Principle 5 the effective abolition of child labour; and
Principle 6 the elimination of discrimination in respect of
employment and occupation.
Environment
Principle 7 Businesses should support a precautionary approach
to environmental challenges;
Principle 8 undertake initiatives to promote greater environmental
responsibility; and
Principle 9 encourage the development and diffusion of
environmentally friendly technologies.
Anti-corruption
Principle 10 Businesses should work against corruption in all its
forms, including extortion and bribery (United Nations,
2005).
Australian Mineral Economics

Mining and Indigenous Populations
Philip Maxwell
Introduction
Aboriginal Australia – Some Historical Background
Aboriginal Australia – Some Recent Comparative Data
Mining and Aboriginal Australia – Pre Mabo
Mining and Aboriginal Australia – The Mabo Case and Recent Developments
Looking to the Future
INTRODUCTION
The Webster’s Dictionary (Gove, 1971) defines indigenous as:
‘living naturally in a particular region or environment’. Yet such
a definition tends to romanticise and simplify this notion.
The United Nations adopted a more complex but complete
definition in 1982. This is that:
Indigenous populations are composed of the
existing descendants of the peoples who
inhabited the present territory of a country
wholly or partially at the time when persons of a
different culture or ethnic origin arrived there
from other parts of the world, overcame them,
and by conquest, settlement or other means,
reduced them to a non-dominant or colonial
situation; who today live more in conformity with
their particular social, economic and cultural
customs and traditions than with the institutions
of the country of which they now form a part,
under a state structure that incorporates mainly
the national, social and cultural characteristics
of other segments of the population that are
predominant.
Although they have not suffered conquest or
colonisation, isolated or marginal groups existing
in the country should be regarded as covered by
the notion of indigenous populations’ for the
following reasons:
1. they are descendants of groups which were in
the territory of the country at the time when
other groups of different cultures or ethnic
origins arrived there;
2. precisely because of their isolation from other
segments of the country’s population they
have preserved almost intact the customs and
traditions of their ancestors which are similar
to those characterised as indigenous;
Australian Mineral Economics
CHAPTER 17
3. they are, even if only formally, placed under a
state structure, which incorporates national,
social and cultural characteristics, alien to
theirs.
Authors such as Burger (1990) estimated that there were about
265 million indigenous people in the world. At that time, the
world’s population stood at around 5.35 billion. Indigenous
populations made up about five per cent of the world’s
population. Indigenous people are spread across more than 85
nations, with about 60 per cent of the total living in China or
India. They include the Inuit and Sami people of the High Arctic,
a wide range of highland and lowland American Indian peoples
in both North and South America, Saharan peoples, pastoral,
hunter/gatherer, rainforest people in other parts of Africa, 32
scheduled tribes in India and Sri Lanka, 55 national minorities in
China, mountain peoples and hill tribes in Asia, at least 33
distinct groups in South East Asia, Australian Aboriginal people,
Maoris in New Zealand, Polynesian and Melanesian peoples of
the Pacific, Mongol peoples, about 40 distinct minority groups in
the former Soviet Union, and the Ainu in Japan.
The growth of industrial capitalism since the beginning of the
Industrial Revolution has been associated with the strong
expansion of mineral exploitation throughout the world. This has
inevitably led to a growing interface between mining companies
and communities in remote areas. It has often had unfortunate
consequences for indigenous peoples. This outcome has taken a
much higher profile in countries such as Australia in the past two
decades and prominently with the recognition by the High Court
of Native Title in the Mabo Case in 1992. Equally, as foreign
(including Australian) mining companies have moved around the
world, it has also taken on considerably greater importance.
Warden-Fernandez (2001, p 4) notes that:
For the indigenous communities their relationship
with the land is deep-seated and is frequently
based on religious beliefs forming part of their
heritage. It is difficult for Western societies to
understand the strong connection between the
195
CHAPTER 17: MINING AND INDIGENOUS POPULATIONS

indigenous people, their land, and its resources. TABLE 17.1

There is a big cultural chasm that in many Stakeholders in resource sector investments.
instances can only be bridged with difficulty.
Writing earlier on ‘How to balance the Aboriginal interest in Affected group Economic Social and Potential total
impact cultural impact impact
resource development,’ Coombs (1982, p 239) put this sentiment
somewhat more dramatically, stating that: Local communities

It is not clear what precisely is meant by the title
of this chapter, a title which I did not choose. But
the use of the word ‘balance’ suggests that what
is sought is some kind of equality in sacrifice and
benefit between the Aborigines concerned and
those who direct and profit from the exploitation
of the resources concerned. Frankly, I doubt
whether, in any real sense, such equality is
possible. What the mining entrepreneur puts at
risk is the opportunity to use his capital and
entrepreneurial skill elsewhere and what he
gains is the extra return he obtains by using
those resources in the chosen mining venture. On
the other hand, what the Aborigines put at risk is
a whole lifestyle; a lifestyle which they have
demonstrated over 200 years that they prefer to
that offered by the white Australians: what he
‘gains’ is financial and material benefit which
past experience suggests will prove destructive of
that lifestyle and of the Aboriginal values it
embodies.
While acknowledging that many Aboriginal people would like
to incorporate some components of European society into their
lifestyles, he argued that those living in a traditional lifestyle
should have:
• the right to refuse to negotiate;
• the right to reject proposed agreements; and
• access to proper advice and expertise concerning the likely
impacts of proposed developments.
As seen in earlier chapters, there are many stakeholders in any
new or continuing mineral sector investment. Most of these
groups are likely to gain from new mineral exploitation. Yet, as
the suggested taxonomy in Table 17.1 implies, there is potential
for the interests of other stakeholders to overwhelm those of
indigenous populations in any politically driven decision-making
process to undertake new resource development.
It is important, however, to acknowledge that mining
companies (particularly those with a global focus) have become
much more culturally aware of indigenous populations in mining
regions in the past 20 years. Many have developed policies and
expertise in their interactions with these groups.
The focus in this chapter is on Aboriginal Australia1. There is
a major interface between mining and Aboriginal Australians in
places such as the eastern and northern goldfields of Western
Australia, the Pilbara, the Kimberley, the Murchison, all of the
Northern Territory, outback Queensland in places such as Weipa,
Mount Isa and Cloncurry and in outback New South Wales. This
is the continuation of a process that began in the middle of the
19th century.
Although the situation is changing as major academic
literature develops, there has previously been a lack of
appreciation of the economy and society of Aboriginal Australia.
The next section endeavours to identify briefly some historical
background and the third section considers some of the recent
1. Technically there are two distinct indigenous populations in
Australia – Aborigines and Torres Strait Islanders. Unless specified
to the contrary, however, the term ‘Aboriginal’ applies to both groups
in the general chapter discussion.
Indigenous Potentially Threatening and Threatening and
positive even potentially even potentially
catastrophic catastrophic
Residential Potentially Potential loss Potential small
positive gain or loss
Occupational Positive Minimal Positive
Others
National Positive Variable Positive
government
Total population Positive Variable Positive
Shareholders Positive None Positive
Financial Positive None Positive
institutions
empirical aspects. We then move to consider ways in which
mining has impacted on Aboriginal populations in remote areas
by reviewing a small selection of relevant literature. The fifth
section is devoted to a discussion of the changed environment
following the High Court decision in the Mabo case during the
early 1990s. This is followed by some brief concluding remarks.
ABORIGINAL AUSTRALIA – SOME HISTORICAL
BACKGROUND
At the time of European settlement in 1788, the British
Government took the view that the Australian land mass had
been terra nullius – ‘land belonging to no-one’. This allowed the
colonising power to claim all of the land mass and to set up a
property rights regime that largely excluded the indigenous
population. In combination with a view that indigenous
Australians were, at best, ‘second-class’ citizens the results were
disastrous for their ensuing development. Indeed it was only in
1967 that Aboriginal people were granted full citizenship rights.
The following brief comment from Mick Dodson (1998)
provides a stark perspective on this historical marginalisation:
Before 1967, Aboriginal and Torres Strait
Islander peoples were… not free, for example, to
travel between imposed state borders nor within
states – no matter where the borders of our
country lay – and we were not entitled to an
Australian passport although many of us had
already fought and died overseas in two world
wars. We had to have permission to marry and we
were not even counted in the census of the people
of this country. In fact, for more than a century of
non-indigenous presence in our country, our
humanity was actively denied – in many places the
births of our children were recorded on livestock
records… Only if we were prepared to embrace
the dominant status quo and renounce our identity
could we have access to the spoils of citizenship –
education, health care, housing and paid
employment, to name just a few.
Studies by anthropologists suggest that the Aboriginal
population of Australia in 1788 stood somewhere in a range
between 315 000 and more than a million (Horton, 1993). Over
the next century and a half, the impact of conflict with European
settlers, land dispossession, disease and general social and
cultural disruption led to a major decline in their numbers.

196 Australian Mineral Economics

 CHAPTER 17: MINING AND INDIGENOUS POPULATIONS

In their recent paper on the health of indigenous Australians,
Howitt, McCracken and Curson (2005) argue that:
Prior to their colonial encounter with Europeans,
Aboriginal Australians enjoyed a level of health
higher than that enjoyed in many parts of Europe
at the same time.
They were apparently free of many of the infectious diseases
prevalent in Europe, such as smallpox, measles, whooping
cough, syphilis, scarlet fever, tuberculosis and influenza and did
not suffer from conditions such as diabetes, hypertension, renal
failure, coronary disease and cancer that have plagued their
recent health profile.
Their relative good health disappeared over the next few
decades, affected in part by their lack of immunity to many of
these European-based diseases, as well as by displacement and
colonisation by the dominant European society.
Butlin (1983, p 175) estimated that, by 1850, the combined
impact of resource competition and introduced disease resulted
in a situation in which the Aboriginal population of South East
Australia stood at only ten per cent of its level in 1788. At a
national level, it was not until the immediate post-World War II
period that this situation stabilised and the Aboriginal population
began rising again. Some details of these movements since
Federation appear in Figure 17.1.
It is important to acknowledge that major mining activity did
not begin in eastern Australia until the 1850s and in Western
Australia until the 1890s. Despite this, as will be seen later in the
chapter, the interface between the mining industry and
Aboriginal Australia has been of considerable significance,
particularly in the past 50 years. Before taking up this theme,
however, it is important to consider some aspects concerning the
recent economic and social status of Aboriginal people in
Australia. Altman, Biddle and Hunter (2004) have recently
compiled a report focusing on socioeconomic change among
Australian indigenous people at a national level2 covering the
three decades between the 19713 and 2001 national censuses.
Considering a range of indicators of employment, income,
housing, education and health, they observe:
2. While acknowledging ‘significant variations in indigenous
socioeconomic status at sub-national, state, section-of-state, and
regional levels’ data difficulties precluded meaningful analysis at
these levels over this period.
3. Covering a longer period was not possible because the Australian
government did not count Aboriginal people in the National Census
until 1971.
4. While it is clear that the rate of natural increase for Aboriginal
people has recently been greater than in the overall population, one
factor contributing to this difference is that some Australians, who
had not done previously, may have identified themselves as
Aboriginals in 2001.
500,000
450,000
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
0
1900 1920 1940 1960 1980 2000
FIG 17.1 - Estimated movements in Australia’s Aboriginal
population 1901-2001.
Overall, we conclude that there has been steady,
although not spectacular improvement in outcomes
over time. These improvements are especially
marked for education, although other areas have
seen some gains.
ABORIGINAL AUSTRALIA – SOME RECENT
COMPARATIVE DATA
At the 2001 census, the estimated resident population of
Aboriginal and Torres Strait Islanders in Australia was 459 000.
This was an estimated 2.4 per cent of the total resident
population. It had grown at a rate of 2.3 per cent per annum since
the 1996 census (compared with the national growth rate of 1.2
per cent per annum)4. This recent growth is more similar to that
in developing than developed nations.
As can be seen from in Table 17.2, over half of the Aboriginal
population lives in New South Wales and Queensland. There are
also significant populations in Western Australia and the Northern
Territory. Relatively few Aboriginals live in Victoria, South
Australia, Tasmania or the Australian Capital Territory. Almost 30
per cent of the population of the Northern Territory is Aboriginal.
The highest percentage in the states is around 3.5 per cent (in
Western Australia, Queensland and, surprisingly, Tasmania). The
comparison in the final two columns of the table provides an
alternative way of recognising that the percentage shares of
indigenous people in Queensland, Western Australia and the
Northern Territory are higher than the shares of those areas in the
national total, while those in the other states and territories are
lower.
Another useful way to assess the fortunes of Australian
Aboriginal people is by considering the component parts of the
Human Development Index – life expectancy, income levels and
educational achievement.

TABLE 17.2
The distribution of Aboriginal and Torres Strait Islander Australians at the 2001 census. (Source: Australian Bureau of Statistics, 2003.)
State and territory Indigenous population Total population Percentage of state or Percentage of Percentage share of
‘000 ‘000 territory population indigenous population total population
New South Wales 135 6575 2.1 29.4 34.0
Victoria 28 4804 0.6 6.1 24.9
Queensland 126 3629 3.5 27.5 18.8
South Australia 26 1486 1.7 5.6 7.7
Western Australia 66 1835 3.5 14.4 9.5
Tasmania 17 471.8 3.7 3.8 2.4
Northern Territory 57 197.8 28.8 12.4 1.0
ACT 4 315.4 1.2 0.9 1.6
Australia 459 19314 2.4 100.0 100.0

Australian Mineral Economics 197

CHAPTER 17: MINING AND INDIGENOUS POPULATIONS

The average life expectancy for Aboriginal Australians in TABLE 17.4

2001 was 57 years5, as opposed to 78 years for the general Formal education experiences of indigenous and non-indigenous
population. The average life expectancy in developing Australians 2001. (Source: Altman and Hunter, 2003; Australian
economies in 2002 was 64.6 years – almost eight years more Bureau of Statistics, 2003.)
than for Aboriginal Australians. Some further details about the Category Indigenous Non-indigenous
age distribution of Australia’s indigenous population at the 2001
census appear in Table 17.3. It was, on average, younger than the Did not go to school (%) 3.2 1.0
total population with a median age of 20.5 years (as opposed to Left school at <15 years (%) 33.4 18.0
36.1 years of the non-indigenous population). This was similar to In full time education
the situation with Maoris in New Zealand (22 years as opposed
15 to 17 year olds (%) 65 88
to 33 years). There was almost double the percentage of children
and less than a quarter of the percentage of older people (2.9 per 18 to 24 year olds (%) 17 41
cent versus 12.8 per cent) in comparison to the non-indigenous Hold post-school qualification (%) 27.9 44.7
population.
• workforce participation rates were lower,
TABLE 17.3
• full-time employment rates were lower, and
Data on age distribution of indigenous and non-indigenous
Australians 2001. (Source: Australian Bureau of Statistics, 2003.) • unemployment rates were higher.
Aboriginal and Torres Non-indigenous While 73 per cent of the non-indigenous population either
Strait Islander people population owned or were purchasing their homes, only a third of
indigenous households were doing so.
Median age (years) 20.5 36.1
As can be seen from Table 17.5, the nature of Aboriginal
Percentage under 15 38.9 20.0 households differed in type and size to the total population in
years
2001. They also owned fewer motor vehicles.
Percentage 65 years 2.9 12.8 In some ways Aboriginal Australians seem to be becoming
and over increasingly urbanised, where the word ‘urban’ typically refers to
living in settlements with populations of 1000 or more. As Table
Every individual respondent in the census is expected to 17.6 shows, 73.6 per cent of Aboriginal people lived in major
complete a question about income before tax. The Australian cities and inner regional areas in 2001. This compared with 87
Bureau of Statistics reports these data in income ranges in per cent of the total population. At the 1991 census, an estimated
various geographical classifications from collection districts 67.6 per cent of Aboriginal people lived in urban areas. Yet much
(groups of around 100 households) to the national level. It also of the increase in urbanisation may be due to a greater
publishes estimates of median incomes for individuals and willingness of people in cities and towns to identify themselves
families. At the 2001 census the estimated median individual as Aboriginals, rather than signifying a migration to urban areas.
annual incomes for indigenous Australians aged over 15 years The main interface of the resources sector in Australia with
stood at just under $11 800. This was about 60 per cent of the Aboriginal people in the recent past has been in those outer
median individual income for all Australians of $19 675. regional areas that the Australian Bureau of Statistics describes
Percentages for Aboriginal people varied between states and
territories, with Tasmania (84 per cent) and Victoria (80 per cent)
being the closest to parity with the total population6. The figure TABLE 17.5
in Western Australia was 60 per cent. The lowest figure was in Selected characteristics of Aboriginal and non-Aboriginal
the Northern Territory, at 47.2 per cent. households in Australia 2001. (Source: Australian Bureau of
Statistics, 2003.)
Median incomes in Aboriginal family units stood at $32 800
per annum, just over 72 per cent of the national family median of Aboriginal people Total population
$45 200. But it is important to emphasise that the average Household type
Aboriginal household contained 3.7 people, compared with the
average of 2.7 persons nationally. There were considerable One family (%) 86.6 76.2
variations between the states and territories in these percentages. Multiple family (%) 6.2 1.2
The participation of Aboriginal Australians in the formal Lone person (%) 7.2 22.6
education system in 2001 also was notably less than for the Number of persons per 3.7 2.7
non-indigenous population. The data (derived from Altman and household
Hunter (2003) and the Australian Bureau of Statistics) illustrate Motor cars per household 1.0 1.4
some key differences. As can be seen from Table 17.4:
• more than a third of Aboriginals left school before age 15
(against 18 per cent for the non-indigenous population); TABLE 17.6
• only 65 per cent of the 15 to 17 year old cohort was still at The geographic distribution of Aboriginal Australians and all
Australian residents 2001. (Source: Australian Bureau of Statistics,
school (versus 88 per cent of the non-indigenous cohort); and 2003.)
• seventeen per cent of 18 to 24 year old Aboriginals were in
full-time education (as opposed to 41 per cent of the Indigenous Indigenous Total
remainder of the population in that age group). population (%) population (‘000) population
Major cities 30.3 139.1 66.3
As well as income, health and education, the Altman and Hunter
(2003) also considered housing and labour markets. They found: Inner regional 42.3 194.2 20.7
Outer regional 27.4 125.8 13.0
5. This estimate appears in Altman and Hunter (2003, p 7). Remote 9.8 44.2 8.5

6. Indeed, the median Tasmanian income for all of its population was Very remote 17.7 81.2 4.5
not much higher than 84 per cent. Total 100.0 459.0 100.0

198 Australian Mineral Economics


as ‘remote’ or ‘very remote’. The estimated indigenous
population of these areas was just over 125 000 and as Altman
(2004, p 518) notes, there are about 1200 indigenous
communities in these areas. In this part of the country the related
issues of land rights, native title and economic development have
become much more important.
The Australian Bureau of Statistics reported that in 2000-01
there were 871 management units conducting mining operations
in Australia. Given the economic geography of the resources
sector, the data in Table 17.7 provide an indicative view of the
interaction between the resources sector and remote indigenous
communities. In addition to this, there was considerable mineral
exploration activity, most of it focused in Western Australia,
Queensland and Northern Territory, where the interface with
remote settlements was greatest. In 2001-02, for instance, more
than half of the estimated $1.5 billion of mineral and petroleum
exploration expenditure took place in Western Australia about
ten per cent in Queensland and approximately 15 per cent in the
Northern Territory.
TABLE 17.7
Operation of mining operations in remote parts of Australia.
(Source: Australian Bureau of Statistics, 2002.)
Industry sector No of units Operation in
remote areas
Coal mining 108 some
Oil and gas extraction 50 some
Iron ore mining 19 considerable
Copper mining 14 some
Gold mining 89 considerable
Mineral sands mining 11 little
Silver-lead-zinc 9 some
Other metal mining 17 some
Other mining 554 little
Total 871
MINING AND ABORIGINAL AUSTRALIA –
PRE MABO
As discussed earlier, Australia’s Aboriginal population declined
substantially from the beginning of European settlement until the
end of 1945. The impact that the expansion of mining had on
surrounding Aboriginal communities must have been significant
following the establishment of large mineral industry based
towns such as Newcastle, Bathurst, Ballarat, Bendigo,
Wollongong, Broken Hill, Kalgoorlie and Mount Isa, as well as a
variety of smaller mining towns and settlements.
For example, in their centenary history of Kalgoorlie Boulder
and the eastern goldfields of Western Australia, Webb and Webb
(1993, pp 176-226) report several cases in which gold miners and
prospectors came into violent conflict with Aboriginal groups.
Blainey (2003) records similar experiences relating to the gold
rushes in the Northern Territory.
Following the exhaustion of alluvial gold, one factor militating
against excessive contact between Europeans working in the
mining sector and Aboriginals was that mining (as opposed to
pastoral and agricultural activities) disturbed a small land area.
Furthermore, a substantial part occurred in arid environments
where surrounding environmental impacts tend to be lower. With
the decline of the industry between 1914 and 1960, its impact
7. See for example the volumes of Cousins and Nieuwenhuysen (1984),
Howitt, Connell and Hirsch (1996), Connell and Howitt (1991),
Rumsey and Weiner (2004) and Langton et al (2004).
Australian Mineral Economics
CHAPTER 17: MINING AND INDIGENOUS POPULATIONS
was also smaller. In remote areas it is arguable that cattle and
sheep station development exerted considerably greater influence
than mining in disturbing Aboriginal lifestyles.
There was a significant change with the onset of the resources
boom in the early 1960s. At this time major new development
took place in regions such as the Pilbara, Central and North
Queensland, the eastern and northern goldfields of Western
Australia and in the Kimberley. Altman and Nieuwenhuysen
(1979, p 41) noted that:
A small number of extremely remote missions
and settlements have come into sudden
prolonged contact with the Western world owing
to discoveries of minerals at or near Aboriginal
reserves. The major discoveries to date have
been bauxite at Gove in the Arnhem Land and at
Weipa in the far north of Queensland, and
manganese at Groote Eylandt off the Arnhem
Land coast. Large extractive plants have been
established by Nabalco, Comalco and GEMCo (a
subsidiary of BHP) respectively. The
communities that have suddenly found these
companies on their doorsteps (literally in some
cases) are Yirkkala mission at Gove, Weipa and
Aurukun in Queensland, and Angurugu mission
and Umbakumbu on Groote Eylandt.
These new projects dramatically enhanced the economic
growth of Western Australia, the Northern Territory and
Queensland. They bolstered national export growth and, during
the early 1970s, increased the exchange rate. Yet, at the local
community level, there seemed a general indifference by mining
companies towards nearby Aboriginal communities. There was
minimal economic contact, though there tended to be some
social interaction. Rogers (1973, p 133) found that in 1968, there
were only 193 Aboriginal people employed by 23 large and
medium-size mining companies throughout Australia. While it is
unreasonable to blame mining companies for adverse social and
economic effects, the clash between the globally focused
Western capitalist system and traditional Aboriginal
communities was almost destined to generate such an outcome.
There is now a broad literature about this area7. In this review,
we consider the case studies by Howitt (1989) and Dillon (1991).
Howitt describes the impacts of mining development of the
Pilbara on the Aboriginal population in the established town of
Roebourne. Dillon (1991) provides a parallel account of the
experience of Aboriginal people with diamond mining in the
Kimberley. The discussion below considers their findings and
seeks to extend them to the present.
Howitt’s study of Roebourne
Between 1960 and 1980 the development of the iron ore industry
dramatically changed the nature of the economy of the Pilbara.
This followed on from the setting up of the Wittenoom asbestos
mines and the somewhat earlier establishment, but equally as
impressive subsequent development, of the oil and gas sector.
During these two decades, Australia rose from being a small iron
ore producer to one of the two major iron ore exporting nations.
By 1980, the Pilbara iron ore mines were responsible for around
a quarter of world iron ore exports.
The pastoral industry had been established in the region since
the 1860s. The small non-Aboriginal population dominated the
local economy during this period and many Aboriginal people
worked on cattle stations. They were generally treated as
second-class citizens, with many of their rights constrained. A
notable historical milestone in response to poor treatment on
pastoral stations came in 1946 with the first major strike and
station walk off by Aboriginals. Some relocated to Roebourne,
one of the few very small towns in the Pilbara (with places such
199
CHAPTER 17: MINING AND INDIGENOUS POPULATIONS

FIG 17.2 - The Shire of Roebourne and the Pilbara region.

as Port Hedland and Onslow) at that time. In the ensuing years 18000
cash payments became more frequent for station workers and
16000
employment conditions made some improvement.
During this period, the town of Roebourne attracted aboriginal 14000

people from outlying parts of the region and its society became
12000
fragmented. A strong presence of Christian fundamentalist Aboriginal people
groups apparently contributed to this situation. At the 1961 10000
Total population
census, the Shire of Roebourne (one of the four shires in the 8000
Pilbara) (see Figure 17.2) had a population of only 568 people,
though notably this figure did not include Aboriginals. 6000

Several events then occurred to facilitate the Pilbara region’s 4000

integration with the global economy. They included the
election of a Liberal state government in Western Australia in 2000

1959 that perceived resource development as a key to the state’s 0

industrialisation, the emergence of the Japanese economy as a 1960 1965 1970 1975 1980 1985 1990 1995 2000

favoured customer for raw materials8, and changing transport

technology that facilitated bulk shipping of low value materials.
Between 1962 and 1975 major mining companies such as
BHP, Hamersley Iron (a Rio Tinto company) and Robe River
(also now associated with Rio Tinto) built ten new company
towns9, four new railways, three new deepwater ports, and
associated infrastructure. The population of the Pilbara, and of
the Shire of Roebourne (which included the new towns of
Karratha, Dampier and Wickham), both increased dramatically.
Data for the Shire of Roebourne appear in Figure 17.3.
The majority Aboriginal population in the early 1960s
changed to become a small minority with less than five per cent
of the Shire’s population ten years later. By 2001 the Aboriginal
population had recovered to be just over ten per cent of the
Shire’s population.
The key projects affecting the Shire and Town of Roebourne
were the Hamersley Iron and Robe River developments with
their associated company towns, railways and ports. The
dramatic growth of the shire’s economic base had little initial
effect on the Aboriginal population of Roebourne. In the early
stages Howitt (1989, p 160) notes that:
8. This placed pressure on the Australian government to remove export
restrictions on iron ore that had been introduced in 1938.
9. Several of these company towns have subsequently been closed (eg
Goldsworthy and Shay Gap). Others such as Newman and Karratha
have become open towns.
FIG 17.3 - Estimated population in the Shire of Roebourne –
1961-2001.
The rapid influx of a construction workforce
dominated by single men, a vastly expanded cash
economy and exclusion from company towns
combined with a downturn in the rural sector and
significant policy changes to further destabilise
fragile community structures. In comparison to
the relative material wealth of the new towns, the
poverty and powerlessness of most Aborigines
was reinforced.
Few Aboriginals were employed on iron ore projects. This was
apparently reinforced by a request from the state Country (now
National) Party to the companies to recruit workers directly from
the cities to avoid disrupting the local pastoral industry.
Construction of port facilities and associated infrastructure
began at Dampier in 1965. Even though it was about 50 km
away, the Roebourne Hotel was the only conventional hotel in
the area. Hamersley employees widely used its facilities. Not
unexpectedly liaisons developed between these workers and local
young Aboriginal women and there was an increase in childbirths
as a result. These placed an additional burden on the local
community and few construction workers took responsibility for
their children.

200 Australian Mineral Economics

 CHAPTER 17: MINING AND INDIGENOUS POPULATIONS

In the ensuing years there were major problems with juvenile

delinquency, general social breakdown, excessive alcohol
consumption, exclusion of Aboriginals from the workforce and
from nearby company towns, and major differences in the quality
of community infrastructure between Roebourne and the nearby
towns of Karratha, Dampier and Wickham.
In terms of the suggested impacts of resource developments in
Table 17.1, the potentially positive economic impacts for
indigenous communities did not materialise, and the threatening
social and cultural impacts did emerge. In the first area, local
Aboriginal people were not recognised as stakeholders and were
therefore unable to share in the large economic rents emerging.
They also had little opportunity to gain employment and earn Argyle Diamond mine
incomes that would have improved their material wealth.
Significant themes in the period since Howitt’s paper have
been the Reconciliation movement and the Native Title era
following the Mabo Case. The assessment by Altman and Hunter
(2003) suggested only marginal improvement in the material
wellbeing of indigenous Australians during the 1990s and at the
turn of the new millennium. At the 2001 census the relative
economic positions of indigenous and non-indigenous
populations in the Shire of Roebourne still differed dramatically.
Median individual incomes for Aboriginal people were about 45
per cent of those of the non-indigenous population, family
incomes 43 per cent and household incomes 67 per cent. In a FIG 17.4 - The Argyle diamond mine and nearby communities.
local government area in which official unemployment rates
were low (5.5 per cent) the indigenous population had an
unemployment rate of 18.3 per cent (or 26.7 per cent if The focus of the study by Dillon (1991) was on the Argyle
employment in the Community Development Employment diamond mine, located 80 km south of Kununurra (see Figure
Projects (CDEP) scheme was excluded). The relative economic 17.4). Argyle Diamond Mines has operated the mine since 1981.
disadvantage remained at apparently similar levels to where it The company was initially a joint venture between Ashton
had been 40 years earlier. Mining, Conzinc Rio Tinto of Australia (CRA) and the Western
Australian Diamond Trust. The company is now fully owned by
This apparent lack of progress in economic terms does, Rio Tinto.
however, overlook a distinct change in view and activities about
indigenous relations within many large mining companies since The mine is large and highly productive. Since it reached
the early 1990s10. While acknowledging that: full-scale production in 1986, the annual average value of its
output has been around $500 million. The company has paid
In the Pilbara region, the mine, rail and port royalties varying between $40 million and $70 million per
developments were carried out in the early 1970s annum to the Western Australian state government. It has
with no reference to Aboriginal people, consistently employed around 1000 people. Yet, throughout its
Harvey (2002) describes this change for Rio Tinto. There is now life, the mine has largely used a fly-in, fly-out workforce. It is
explicit recognition of social and cultural issues in local now entirely a fly-in, fly-out (75 per cent) and drive-in drive-out
communities by the company and with it a new willingness to (25 per cent from Kununurra and surrounding areas) operation.
employ indigenous people who live near resource developments. The impact of the mine has been important for the Shire of
In March 2005, the Rio Tinto website reported that eight per cent Wyndham East Kimberley, and of some significance for the Shire
of the Hamersley Iron workforce was indigenous Australians of Hall’s Creek. But the growth of tourism and the continuing
with a goal of 12 per cent by 2005. With more than 2000 people importance of agriculture has meant that mining has affected the
working in their Pilbara operations, the indigenous workforce is area’s economy relatively less than the situation in the Pilbara.
now close to 200 people. The economic implications for As Figure 17.5 shows, population growth in the East Kimberley
Aboriginal people living in Roebourne are much more positive has been substantial since 1976 but it has not been explosive and
than they were in the early 1970s. overwhelmed the strong indigenous influence.
16000
Dillon’s study of Argyle Indigenous
14324
14000
Europeans first settled the East Kimberley region in the 1880s. Non-Indigenous 12062
Families such as the Durack’s initiated the pastoral industry, and 12000 Total
10741
there was a gold rush in areas such as Hall’s Creek at about the
10000
same time. During this period, the small port of Wyndham and 8593
the inland settlement of Hall’s Creek were established. The next 7800
8000
major development came in the 1960s, when there was major 6005
public investment to develop the Ord River irrigation scheme. 6000
5249
Using water from the newly constructed Lake Argyle, the largest
4000
man-made lake in Australia, this scheme sought to convert 4018 4088
3799
70 000 hectares of rangeland and pasture to irrigated farming 2000 3194
land. The new town of Kununurra was established to service the 2438

Ord River scheme. 0

1975 1980 1985 1990 1995 2000 2005

10. This has formed part of their more recent focus on sustainable FIG 17.5 - Population movements in the Shires of Wyndham East
development. Kimberley and Hall’s Creek, 1976-2001.

Australian Mineral Economics 201

CHAPTER 17: MINING AND INDIGENOUS POPULATIONS
Dillon was concerned with the physical, social and economic
impacts of the mine on local Aboriginal people. In a relative
sense the physical impacts have been small. Even though the
mine is large, it is isolated and remote. The nearest Aboriginal
population at Mandangala is 10 km away. There are other small
Aboriginal communities at Doon Doon (25 km away) and
Warmun (35 km from the mine).
Because of its remoteness and small area of operation, the
physical impact of the mine, in comparison to the Ord scheme
and the land degradation of pastoral activities has been minimal.
The social, economic and cultural impacts have been of greater
concern.
Economic impacts on balance appear to have been positive,
yet Dillon perceives them to be relatively modest. At one level
the company, through its ‘good neighbour policy’, supplemented
infrastructure in the nearby communities and apparently made
small royalty payments to nearby Aboriginal groups for two
decades. This policy tightened up during the 1990s to try to
ensure that local communities used such payments productively.
One assessment of the economic status of indigenous people in
the Wyndham East Kimberley Shire can be gained from the 2001
census indigenous peoples profile by comparing labour force,
education and income data (see Table 17.8). While Aboriginal
people have lower workforce participation rates (55.2 per cent
against 70 per cent) and higher unemployment rates (ten per cent
against three per cent), these differences were not as large as
between indigenous and non-indigenous groups in the Shire of
Roebourne. By contrast, however, there are real gaps in
educational attainment between Aboriginal and non-Aboriginal
people. Relative income levels of indigenous people were similar
to those in the Pilbara. Unless, or until, indigenous people in the
East Kimberley increase their human capital, major differences
seem likely to remain in the economic status of indigenous and
non-indigenous groups.
In the wake of the emerging focus of mining companies on
sustainable development, the key stakeholders – traditional
landowners, Argyle Diamonds and the Kimberley Land Council
– recently negotiated the Argyle Participation Agreement. With
its focus on economic participation and regional development,
the movement towards greater indigenous employment is
reflected in this document. According to Rio Tinto (2005) Argyle
Diamonds’ indigenous workforce is currently 21 per cent. It aims
to increase this to 40 per cent by 2007, although it is not clear
whether this change will come about as a result of a reduced
mining workforce or not.
TABLE 17.8
Labour force, educational and income data for indigenous and
non-indigenous populations, Wyndham East Kimberley Shire,
2001 census. (Source: Australian Bureau of Statistics, 2003.)
Indigenous Non-indigenous
Labour force indicators
Participation rate (%) 55.2 70.2
Unemployment rate (%) 10.0 3.0
Education
Did not go to school (%) 7.2 0.3
Completed year 12 (%) 7.6 40.8
Bachelor degree and above (%) 1.5 15.2
Median weekly incomes
Individual ($) 180 550
Family ($) 550 1100
Household ($) 550 900
11. Conzinc Rio Tinto Australia was the earlier name of Rio Tinto in
Australia.
202
While the town of Kununurra has emerged as a significant
sub-regional centre, Dillon (1991, pp 144-45) points to the
interesting and positive associated development of Aboriginal
people establishing outstation communities. He perceives this as:
…a partial reaction to non-Aboriginal urbanisation
and the pervasive dominance of non-Aboriginal
forms of ‘development’.
Cultural impacts are primary land-related. In its early years
the Argyle site generated considerable controversy because of
the conflict between sites of significance (as set out in the 1972
Aboriginal Heritage Act) and the political and economic
imperatives of the state government pursuing policies of vigorous
resource development.
The action of CRA11 of undertaking exploration work on three
sites of significance in 1980 brought planned court action. The
plaintiffs were unable to proceed with this because the WA
Museum refused to act to obtain evidence that CRA had
breached the Heritage Act. The company subsequently
negotiated a financial agreement with local Aboriginal people at
Mandangarla and later with members of the Doon Doon and
Warmun communities. This led to the ‘good neighbour’ policy
already mentioned. This has not adversely affected the long-term
development of the mine but it highlighted the sites of
significance issue and the Aboriginal relationship to the land,
which has become so important in the past decade.
In summary, the impact of the mining industry on the welfare
of local indigenous communities in remote Western Australia has
so far been marginal. While this situation appears at last to be
changing, a lot of hard work seems to lie ahead.
MINING AND ABORIGINAL AUSTRALIA – THE
MABO CASE AND RECENT DEVELOPMENTS
The discussion of the preceding section conveniently sidestepped
the issue of land rights. Deriving from the doctrine of terra
nullius the ownership of mineral resources in Australia is largely
vested in the Crown. The essence of the prevailing regime is
described quite effectively by the following quote from Industry
Commission (1991):
In Australia ownership of mineral resources
generally lies with the Crown (in practice
State/Territory and Commonwealth governments),
regardless of who owns the land on the surface.
This seems to reflect a widely held belief that
mineral deposits are a fortuitous ‘gift of nature’
and that any net benefits flowing from their
exploitation should accrue to the community as a
whole rather than to whoever happens to own the
surface rights.
Subsequent development of these resources is based on the
‘regalian’ system where the Crown ‘leases the rights to exploit
these resources to private firms under set conditions’.
When he authored the report of the Aboriginal Land Rights
Commission in 1974, Justice Woodward noted that:
At the beginning of the year 1788, the whole of
Australia was occupied by the Aboriginal people
of this country. It was divided between groups in
a way which was understood and respected by
all.
Over the last 186 years, white settlers and their
descendants have gradually taken over the
occupation of most of the fertile and otherwise
useful parts of the country. In doing so, they have
shown scant regard for any rights in the land,
legal or moral of the Aboriginal people.
Australian Mineral Economics

Always an underlying issue in the relationship between
indigenous and non-indigenous Australians, land rights emerged
strongly as a key issue in the 1970s and 1980s. The matter
impinged on the resources sector as miners extended their
activities into more remote areas.
The matter reached a high point in 1992 when the High Court
of Australia brought down the Mabo judgement. This followed a
series of earlier court cases and the passage of Aboriginal land
rights legislation in the Northern Territory and South Australia. It
has been succeeded by two major pieces of Commonwealth
legislation, as well as some further High Court judgements.
In rejecting the doctrine of terra nullius the High Court judges
recognised native title in certain situations. This judgement
signalled potential and actual change to the position of
indigenous Australians as stakeholders in mineral development.
Mason (1996, p 3) describes the decision in the following terms:
The High Court held that indigenous inhabitants
of Australia held customary native title in their
traditional lands in unalienated Crown land in
Australia so long as it had not been validly
extinguished by legislative or executive action,
provided they have not surrendered their title or
lost their connection to the land.
Explaining native title, Horrigan (2003, p 19) argues that:
Native title rights are traditional rights of access,
use, or occupation concerning lands or waters.
They are personal or group rights based on
traditional laws or customs. The traditional land
rights of indigenous Australians survive unless
the government lawfully takes them away, they
are surrendered, or the indigenous connection
with land according to traditional laws and
customs is otherwise severed.
At the time, there was major concern in the resources sector
that this judgement would adversely affect mineral exploration
and mine development as Australia moved to a ‘post-colonial
view of the world’.
Yet even with recognition of limited native title rights, the
Crown continues to claim virtually all subsurface mineral rights.
Commentators such as Howitt (2005) observe that:
It is this claim, rather than the claims of
individual mining companies to have rights
derived from various state agencies, to mine
lands that are subject to claims of indigenous
ownership, that underpins tensions between the
industry and indigenous groups.
Despite these tensions, in his recent review paper, Horrigan
(2003, p 17) argues:
Yet, after more than a decade of Australian
native title law, at least ten landmark High Court
cases, native title legislation in every Australian
jurisdiction, and millions of dollars of legal
advice on native title matters across the
community, farmers have not lost their land or
any existing rights across the board because of
native title, miners have not lost their mining
titles wholesale on native title grounds, lawful
commercial rights still prevail over competing
native title rights, and relatively few native title
claims have succeeded in court.
12. Perhaps this was a positive event because it encouraged domestically
focused entrepreneurs to look more widely at potentially profitable
opportunities.
Australian Mineral Economics
CHAPTER 17: MINING AND INDIGENOUS POPULATIONS
TABLE 17.9
Landmarks regarding native title and resource development.
Date Event Result
1788-1992 Terra nullius doctrine Indigenous Australians had no
in force land rights.
1992 Mabo judgement by Recognition of the existence of
High Court native title.
1993 Commonwealth National regime for native title
Native Title Act including ‘right to negotiate’ for
native title claimants.
1997 Wik judgement in Native title could co-exist with
High Court pastoral leases.
1998 Ten point plan and Native Sought to overcome
Title Amendment Act complexities in initial
legislation. Tended to favour
government and business
interests.
The entries in Table 17.9 provide a brief summary of recent
developments.
The Mabo judgement and the subsequent Commonwealth
Native Title Act passed by the Keating government in December
1993 came as a shock to the Australian mining industry. Over the
next few years it introduced growing uncertainty with respect to
mineral exploration in greenfield areas and encouraged many
companies to focus their exploration activity on current mining
leases instead. As time went by, this uncertainty added to the
attractiveness of Australian-based companies exploring in other
nations12.
The major industry criticisms of the new Commonwealth
legislation, and the requisite state acts to support it, related to
their complexity, the delays involved in processing claims for
native title compensation and the impact of this on the
profitability of projects in a period in which mineral prices and
exchange rate movements were unpredictable. Also while native
title had been extinguished on freehold land, uncertainty
remained about the relationship between pastoral leases and
native title.
In the Wik case judgement in 1997 and some later decisions,
the High Court established that when government grants pastoral
leases, this does not necessarily extinguish surviving native title.
Importantly, however, when these two forms of title co-exist,
leaseholder rights take priority. This judgement had application
as well to situations in which there were mining titles on
leasehold land.
Competing native title claims over mineral prospective areas
further confused the situation facing miners. Financial
institutions were also indecisive in their views about providing
finance and security requirements.
With its historical sympathies towards resource sector
development, the newly elected Howard Coalition government
sought to ‘strike a fair balance between respect for native title
and security for pastoralists, farmers and miners’ in 1997 when it
introduced the Native Title Amendment Act based on its ten-point
plan. As Horrigan (2003, p 21) explains, this covers the
following areas:
• extinguishment of native title,
• validation of pre-Wik actions,
• facilitation of public infrastructure and government actions,
• interaction between tenure rights and native title,
• restrictions on indigenous rights to negotiate,
• frameworks for indigenous land use agreements, and
• ‘just terms’ compensation.
203
CHAPTER 17: MINING AND INDIGENOUS POPULATIONS
The legislation changes the balance away from indigenous and
towards business and commercial interests. Despite this
assessment, one can also argue that mining companies have
accepted that indigenous Australians are now stakeholders in the
mineral development process. Almost all now opt to negotiate
directly with Native Title claimants, rather than pursue
time-consuming judgements through the court system. The
resulting indigenous land use agreements combine some
recognition of social and cultural issues, limited access to
economic rents and some potential for Aboriginal people to
benefit from surrounding economic development.
And, as discussed elsewhere in this volume, there has been an
apparently inexorable trend towards mines operating as ‘fly-in,
fly-out’ operations and in remote and even not so remote
hinterland areas since the 1980s. One benefit of this practice is
that it provides minimal interference with the societies and
cultures of nearby indigenous communities.
Furthermore, as long as mining companies can adjust their
work practice requirements, and members of indigenous
communities are amenable to training and would like
employment, there are potential economic development
opportunities available for them. Particularly in periods of high
mineral demand, when labour turnover in traditional mining
workforces is high, the opportunities for indigenous workers in
nearby local communities to establish themselves as alternative
cost-efficient and stable sources of labour increase significantly.
As mining companies recognise this option, they become much
more amenable to using their services.
The above case studies for the town of Roebourne and for the
Argyle diamond mine confirm that large companies such as Rio
Tinto have been recognising and taking advantage of this
potential. These developments follow from similar successful
efforts in places such as the Red Dog zinc mine in Alaska and in
remote areas of Canada such as the North West Territories where
the Ekati and Diavik diamond mines are now in production.
Global mining corporations are now following similar practices
in many developing nations.
The trend towards negotiated agreements
Against this background, an important associated trend in recent
years has been a move away from the community management/
good neighbour policies13 associated with projects such as the
Argyle diamond mine, towards formal negotiated agreements
with local Aboriginal populations. Such frameworks hold
apparent promise for Aboriginal populations to claim economic
rent in a more effective manner, while also addressing important
social and cultural issues.
O’Faircheallaigh and Corbett (2005, p 634) classify the
emergence of such agreements in Australia in three distinct
legal/administrative contexts. These are:
• those resulting from legislation that recognises Aboriginal
ownership of land and does not permit mineral development
without formal agreement between Aboriginal landowners
and mining companies;
• those in which legislation ‘creates an opportunity for
negotiation of agreements, but allows mining to proceed in
the absence of consent from Aboriginal landowners’; and
• those in which mining companies have no legal requirement
to negotiate with traditional Aboriginal owners because they
13. A typical academic critique of such policies is that they patronise
local indigenous populations in a demeaning way. Lawrence (2005)
provides such an analysis in her assessment of employment and
training programs available to the Warlpiri people in the Central
Australian gold mining industry.
204
already hold mining leases granted before the Mabo decision,
but where they decide to negotiate such agreements because
of company policy.
The authors identify the Aboriginal Land Rights (Northern
Territory) Act 1996 as an important example of the first
legal/administrative context, while the Commonwealth Native
Title Act 1993 provides the main illustration of the second
situation. In the first context, Aboriginal negotiators are in a
stronger bargaining position than in the second, all things being
equal.
The third legal/administrative context is also important. Even
though they are not legally required to do so, large companies
may choose to negotiate agreements with local indigenous
people for a variety of reasons. The most important seems to be
that such policies are more likely to ensure their continuing
licence to operate in a broader global environment over the long
term. The decision by Rio Tinto in the 1990s to follow such a
practice is noteworthy in this regard though it seems to have been
followed as well by other large companies.
Despite this apparently positive change for indigenous
populations, there has been some broad criticism of the
outcomes. The recent papers by O’Faircheallaigh and Corbett
(2005) and Lawrence (2005) provide two examples of such
analysis. In focusing on indigenous participation in the
environmental management of mining projects, O’Faircheallaigh
and Corbett consider 45 agreements using a range of assessment
criteria. They conclude that:
While agreements certainly have the potential to
enhance Aboriginal participation in environmental
management, a majority do not have that effect,
reflecting the weak negotiating position of many
Aboriginal peoples in their dealings with mining
companies.
Mining professionals who work in these environments must
now recognise the key importance of appreciating and respecting
social and cultural differences between indigenous populations
and global capitalism.
LOOKING TO THE FUTURE
The interface between global capitalism and indigenous
populations with new and existing mining projects is destined to
continue. An optimist might suggest that the progress that is now
being made in places such as the Pilbara and the East Kimberley
will also continue. As a result, indigenous Australians will
emerge during the next two or three decades as successful
stakeholders in a world-class mining industry. Yet they will also
need to be provided with greater educational and occupational
opportunities so that they can pursue alternative lifestyle
opportunities when the mines in their areas become exhausted.
Whether they can withstand the seductive appeal of global
capitalism and maintain their cultural identity remains a major
question. Governments may be able to assist their cause by
putting in place sympathetic policies. But in many ways,
Australian Aboriginal people will have their future in their own
hands.
The general discussion of this chapter about the interface of
mining with Australia’s indigenous population will happen with
much greater intensity in many other countries in the future.
Australian mining professionals, many of who will be working in
remote areas and mineral rich developing nations will face the
difficult, though stimulating challenge of operating in close
proximity with indigenous people. Maintaining social and
cultural diversity, while delivering economic benefits and
economic opportunity to generate sustainable economic
outcomes, will continue to be a major task.
Australian Mineral Economics

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205

Minerals and Regional Development
Philip Maxwell
Some Introductory Remarks
Mining – Towns, Cities and Regions
The Australian Regional Framework
Mining and Australian Regional Development – A Historical Perspective
Socio-Economic Indicators
Assessing Economic Impacts
Assessing Social Impacts
Fly-in, Fly-out and Regional Development
SOME INTRODUCTORY REMARKS
Exploitation of minerals and energy has been closely associated
with the growth and development of the world economy
throughout its recorded history; yet there is considerable debate
about the effect of mineral development on small regions. This
comes in part because minerals are non-renewable. It is also
influenced by the fact that mines and oil wells generate
economic rent, which may be claimed by stakeholders in a
variety of ways – some productive and some not. A more recent
consideration is the rise of ‘fly-in, fly-out’ work practices. While
a particular interest in this final chapter is in the impacts of
minerals and energy exploitation on the fortunes of mining towns
and communities, and their subsequent sustainability, it also
recognises the impacts of mineral development on larger
sub-national regions.
The authors of Breaking New Ground (IIED, 2002) for
example, take a small region focus, when they suggest the
following taxonomy to assist consideration of the social and
economic status of communities affected by mining at the small
area regional level:
• occupational communities – households or families who
derive all or most of their income from mining;
• residential communities – households or families who live
in the geographical area affected by mining; and
• indigenous communities – households or families with an
ancient and cultural attachment to the land where mining
occurs or has an impact.
Each of these communities (living in small regions) will be
affected by mining in different ways. Acceptable policy
outcomes from new mineral development will presumably satisfy
each of these groups, moving them from a less desirable to a
more desirable social and economic status. Where this does not
happen conflict is likely to arise.
Australian Mineral Economics
CHAPTER 18
As the level of analysis proceeds from smaller to larger
regions, the economic and social fortunes of local communities
tend to receive less sympathy from policymakers as they take a
broader regional perspective. This was the case, for example,
when the Western Australian government decided to introduce a
gold royalty in 1998. Even though producers of other minerals
paid such royalties, gold producers had always been exempt. The
protestations of impending doom from gold producing areas
were largely ignored as the government phased in a royalty
regime, which paralleled that of other non-industrial minerals.
A rather different example of local regional impacts, which
has had wider ramifications, relates to the fortunes of the Ok
Tedi copper mine in Papua New Guinea. The communities
downstream from the mine clearly seem to have lost out because
of the discharge of wastes into the Sepik River. Their misfortunes
have been the subject of rulings in Australian courts. In seeking
to retain its public image as a responsible global mining
company, BHP Billiton, gave up its share of the joint venture that
operates the mine. One possible outcome from the episode was
the closure of the mine. Yet, particularly because it provided and
still provides an important source of revenue to the national
coffers, the government in Port Moresby chose to continue to
allow its operation.
Analysts take a variety of perspectives in considering the
impacts of mining in regions. These include economic, social
and health, cultural and environmental. From an economic
perspective regional governments typically receive royalty
streams and perhaps also taxation receipts from new mine
developments. Those residents displaced by new mines will also
receive financial compensation but typically will forfeit their
homes and access to their land. New mines also generate
potential employment opportunities and higher incomes in a
region. Employment and income multipliers, which are discussed
in the next section, provide opportunities for regional business.
Another benefit comes with the improvement of infrastructure
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(airports, roads, railways, water supplies, sanitation systems,
electricity), which can often be used by local industries that
otherwise would not be established.
New mines may also improve the social fabric of a region by
generating revenue to alleviate poverty, malnutrition, illiteracy
and poor health in previously depressed areas. Yet they may also
increase social problems because of the displacement of nearby
communities as a result of pollution or by migrant workers,
acting as a disruptive influence with respect to local social
control. Some of the adverse social influences associated with
mining regions can arise from greater consumption of alcohol
and other drugs, increased gambling, prostitution and greater
levels of domestic violence.
Workers with higher incomes are able to afford better health
services and better nutrition. Yet, because many miners have
tended to lead excessive lifestyles, associated with some of the
adverse social influence just mentioned, this has undermined
their health. Also, populations in isolated regions (particularly
indigenous populations) tend to be vulnerable to outside diseases
brought in by the miners.
As seen in the last chapter, foreign cultural values may clash
with the cultural identity of local aboriginal populations. This
can dramatically influence traditional ways of life. If it is
possible, local populations should negotiate to retain their
customs. This has been happening more and more since the
recognition of native title in Australia after 1991. The emergence
of fly-in, fly-out work practices in remote locations also appears
to have had a positive effect in this regard.
Although their formal education has been concerned almost
entirely with developing technical competence, mining
executives operate in a challenging world where an
understanding of the socio-economic impacts of mineral
development in smaller and larger regions is critical. To obtain
and then retain a ‘licence to operate,’ they must appreciate the
initial socio-economic status of people living of the region in
which they operate, and regional populations need to be
convinced that their presence will improve their quality of life.
Given the social and economic circumstances of potential mining
regions, mining company professionals also need to be
convinced that they can operate profitably.
The subsequent discussion is divided into four parts. The next
two sections are concerned with describing mining towns and
regions, and setting them within the broader Australian regional
1. Kalgoorlie has, of course, also derived great benefit from nickel
mining since 1967.
2. Karratha is also an oil and gas centre.
framework. The fourth section reflects on the social impacts of
mining, while the fifth considers ways in which economists
typically assess the impacts of activities such as mining. The
focus of the final section is specifically on assessing the impacts
of ‘fly-in, fly-out’ work practices on regional development.
MINING – TOWNS, CITIES AND REGIONS
Minerals and energy have driven major economic development
and growth in many large regions. The list includes places such
as South Wales, Yorkshire, Tyneside, the Ruhr, Silesia,
California, Pennsylvania, Texas, Oklahoma, Nevada, Alberta, the
Transvaal (now Gauteng), Chile’s Antofagasta region, and
probably every Australian state. Blainey (2003) provides an
excellent historical account of the regional impacts of minerals
and energy discovery and exploitation on Australian economic
development.
Many major cities owe much of their initial and even current
prosperity to an association with the minerals and energy sector.
Places such as Houston, Dallas, Denver, San Francisco and
Pittsburgh, Toronto, Calgary and Vancouver, Lima, Santiago and
Belo Horizonte, Johannesburg, and Melbourne, Perth and
Brisbane might all be included in this list. Additionally, many
regional cities have depended more directly on mining for some
or all of their history. This group includes places such as
Newcastle in England (coal), Sudbury in Canada (nickel),
Kimberley in South Africa (diamonds), and Antofagasta and
Calama in Chile (copper).
The list of significant towns and cities in regional Australia
that owe much to mineral resources includes:
• Newcastle, Wollongong, Morwell/Moe/Yallourn, Mackay
and Collie (all coal);
• Bathurst, Ballarat, Bendigo and Kalgoorlie (all gold)1;
• Broken Hill, Mount Isa and Port Pirie (base metals);
• Port Hedland, Karratha2 and Whyalla (iron ore); and
• Sale (oil and gas).
In many cases, these towns serve as the major centre for a
substate region. Among the 60 or so such regions in Australia,
more than ten are either current or former mining towns.
And then there are the smaller mining (or ex-mining) towns.
These are located in every state. An indicative list appears in
Table 18.1. While not including all such towns, it identifies
another 60. Intuitively, it seems that the mining industry has
made a significant contribution to Australian regional
development. The entries in this table do not include either ghost
towns or company towns that have closed and cease to exist.

TABLE 18.1
Some current and former small mining towns in Australia.

State or Territory Current Former

New South Wales Cobar, Tibooburra, White Cliffs Blayney, Emmaville, Glen Innes, Gulgong, Inverell,
Tenterfield, Lithgow
Victoria Castlemaine, Beechworth, Beaufort, Chiltern, Clunes,
Daylesford, Heathcote
Queensland Blackwater, Moranbah, German Creek, Biloela, Gympie, Mary Kathleen, Mount Morgan, Stanthorpe
Cloncurry, Charters Towers, Weipa
South Australia Andamooka, Coober Pedy, Roxby Downs, Leigh Creek Iron Knob, Kadina, Kapunda, Burra, Moonta
Western Australia Southern Cross, Norseman, Coolgardie, Kambalda, Northampton
Leonora, Laverton, Wiluna, Meekatharra, Mount
Magnet, Cue, Newman, Tom Price, Leinster,
Parraburdoo, Pannawonnica, Capel, Pinjarra,
Greenbushes, Eneabba
Tasmania Queenstown, Beaconsfield, Rosebery Zeehan
Northern Territory Gove, Jabiluka, Pine Creek, Tennant Creek Batchelor

208 Australian Mineral Economics


Taking a cultural heritage perspective, Moore (1998) provided
a useful survey of current and former mining towns in Western
Australia. His list contained:
• three regional centres (Kalgoorlie Boulder, Port Hedland and
Karratha);
• six towns classified as subregional centres;
• four company towns;
• 27 small towns;
• 17 notable former mining towns; and
• 114 other gazetted mining towns.
In Western Australia, the Australian state that depends most on
mining, there were 131 towns (‘Ghost towns’) that no longer
exist, and 40 that are currently still operating. This observation is
a reflection of the finite nature of resources and the historical
reality that, in many cases, mining has not generated sustainable
economic activity in small regions3.
A factor complicating the situation further has been the rise of
‘fly-in, fly-out’ work practices. Although the final section of the
chapter focuses specifically on this issue, it is important at this
point to define clearly what it means. Storey (2001a) defines
‘fly-in, fly- out’ (FIFO) mining operations as:
those which involve work in relatively remote
locations where food and lodging
accommodations are provided for workers at the
worksite, but not their families. Schedules are
established whereby employees spend a fixed
number of days working at the site, followed by a
fixed number of days at home. What
differentiates this form of organisation from
other work involving periodic absences from
home are the regular patterns of work onsite
followed by a period offsite and the nature of the
accommodation arrangements.
As Storey and others have noted, the FIFO terminology is
misleading because some workers do not fly to the mine site or
the oil rig at which they work. They drive in, travel by bus and
some even come by boat or hovercraft.
The incidence of FIFO work practices has become more
pervasive over the past 20 years, with perhaps 70 mines in
remote parts of Australia now fully staffed in this way. The
practice now applies more and more throughout the world – in
Canada, South America, Asia and Africa. It means that cities
such as Perth, but also to a lesser extent Brisbane, Melbourne,
Townsville, Mandurah and Cairns provide the residences of
managers, mining professionals and other operational personnel.
As much as 50 per cent of the mining workforces in Western
Australia and the Northern Territory now appear to be FIFO, and
the percentage is also high in Queensland.
3. For a more detailed discussion of these towns see also Maxwell
(2004).
4. The adjustments are splitting the Moreton Statistical Division in to
Gold Coast (south of Brisbane) and Sunshine Coast (north of
Brisbane), dividing the South West Statistical Division in Western
Australia into Peel (based around Mandurah) and a smaller South
West (based on the Bunbury, Busselton, Collie and Margaret River
areas), merging South West and Central West in Queensland;
merging Lower Great Southern and Upper Great Southern in
Western Australia, and merging Hobart and Southern in Tasmania.
5. Small area data are not readily available for regional product or
exports that have been used to classify mineral economies at national
level.
Australian Mineral Economics
CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT
THE AUSTRALIAN REGIONAL FRAMEWORK
There has been a largely consistent and widely accepted substate
regional framework in operation in Australia for the past three
decades. The genesis of this system came largely from the work
of geographers such as Malcolm Logan, associated with the
Growth Centres program initiated by the Whitlam Federal
Government in the early 1970s. They generated a taxonomy of
substate regions based on standard classification criteria of
homogeneity and nodality. In this system local government
areas do not overlap substate regional boundaries. While one can
question some of the substate regional definitions on grounds
that meaningful regions traverse state borders (eg Albury-
Wodonga, Richmond-Tweed/Gold Coast), the system has
generally worked well.
For the past six censuses since 1976, the Australian Bureau of
Statistics has reported a wide range of consistent economic and
social data for Statistical Divisions (generally equivalent to
substate regions), Statistical Subdivisions and Local Government
Areas, and some other areas. These data sets cover areas such as
demography, income, marital status, education, religion, ethnicity,
housing, labour market activity, and motor vehicle use. There were
57 Statistical Divisions at the 2001 census.
With the passage of time, the depopulation of the hinterland in
certain states, and the continuing significant movement of
population to coastal areas, adjustments to this framework may
now be overdue. The classification provided in Table 18.2 uses
an adjusted version of the ABS framework4. The net result is a
decrease in regions from 57 to 56.
A summary table, Table 18.3, highlights those substate regions
that are sources of major mineral production. Although the
classification is somewhat intuitive5, 11 regions have been listed
in this table. Two are in New South Wales, two in Queensland
five in Western Australia and two in the Northern Territory.
There is significant mineral production in several other regions.
TABLE 18.2
A taxonomy of Australian substate regions – 2004.
(Source: Australian Bureau of Statistics, 2002.)
State Regions Names of regions
New South Wales 12 Sydney, Hunter, Illawarra,
Richmond-Tweed, Mid-North Coast,
Northern, North Western, Central-West,
South Eastern, Murrumbidgee, Murray,
Far West
Victoria 11 Melbourne, Barwon, Western District,
Central Highlands, Wimmera, Mallee,
Loddon, Goulburn, Ovens-Murray, East
Gippsland, Gippsland
Queensland 11 Brisbane, Gold Coast, Sunshine Coast,
Wide Bay-Burnett, Darling Downs,
Fitzroy, Central and South West,
Mackay, Northern, Far North, North
West
South Australia 7 Adelaide, Outer Adelaide, Yorke and
Lower North, Murray Lands, South East,
Eyre, Northern
Western Australia 9 Perth, Peel, South West, Great
Southern, Midlands, South Eastern,
Central, Pilbara, Kimberley
Tasmania 3 Hobart and Southern, Northern,
Mersey-Lyell
Northern Territory 2 Darwin, balance of Northern Territory
ACT 1 Canberra
Total regions 56
Note: Regions that differ from statistical divisions appear in bold typeface.
209
CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT

TABLE 18.3 Australian primary school children in the 1950s learned about
Australian mining regions 2004. how the mines at Iron Knob had underpinned the economy of the
Iron Triangle towns of the Northern region of South Australia
Mining regions Main centres Main minerals Per cent (and supplied BHP steelworks at Newcastle and Port Kembla, as
mining well as at Whyalla). But is was the exploitation of deposits in the
employment
Pilbara at places such as Mount Whaleback, Tom Price,
Hunter (NSW) Newcastle Coal 3.08 Parraburdoo and Pannawonnica that stimulated the development
Far West (NSW) Broken Hill Silver, lead, 6.76 of that remote region after the early 1960s.
zinc Oil and gas wells in Bass Strait have played a strong role in the
Mackay (Queensland) Mackay Coal 7.77 regional prosperity of East Gippsland, while oil and gas on the
North West Mount Isa Copper, lead, 15.23 North West Shelf has had an equal, if not greater, role than iron
(Queensland) zinc, phosphate ore in the impressive economic fortunes of the Pilbara.
South West (WA) Bunbury Coal, mineral 4.27 In summary, it is clear that, in addition to the 11 mining
sands regions specified, perhaps eight other regions, particularly in
Peel (WA) Mandurah Bauxite 5.21 Victoria and New South Wales, formerly held that status. In these
later cases, the closure of mines led to the need for regions to
South Eastern (WA) Kalgoorlie Gold, nickel 18.17
redefine themselves in an economic way. In some cases they
Boulder
found difficulty in achieving this, enduring high unemployment
Pilbara (WA) Port Hedland, Iron ore, oil 24.74 rates and lower incomes for extended periods after mines had
Karratha
closed.
Kimberley (WA) Broome, Diamonds, base 2.95 It is instructive to mention one other important set of trends
Kununurra metals
before completing this section. First there has been what appears
Balance of Northern Alice Springs Gold 3.86 as an inexorable movement towards greater metropolitan
Territory dominance in Australia during the past century. One view of this
can be seen in Figure 18.1, which shows an increase in the
percentage population share of each state capital city by at least
20 percentage points between 1909 and 1999. More recently
MINING AND AUSTRALIAN REGIONAL there has also been noticeable movement of population into
DEVELOPMENT – A HISTORICAL PERSPECTIVE desirable coastal communities within easy driving distance of the
large cities.
In Chapter 2, it was argued that gold and other minerals had
strongly facilitated Australian economic development from the
1850s onwards. An important dimension of that process related
initially to populating hinterland regions, the associated
development of a strong agricultural sector and the development
of associated infrastructure (roads, railways, power and water
supply, hospitals, schools, etc).
The Gold Rushes of the 1850s facilitated the economic
emergence of towns such as Ballarat, Bendigo and Castlemaine
in Victoria, and Bathurst and Orange in New South Wales, as
centres of prosperous mining and agricultural regions.
With the exhaustion of alluvial gold, the prospectors moved on
to places such as Young, Forbes and Gulgong in New South
Wales. They then progressed north into Queensland with rushes
at Gympie, Mount Morgan, Charters Towers and the Palmer
River. Having reached the tropics, they moved west, arriving at
Pine Creek in Northern Territory by the early 1870s. By the early
1880s, they had reached Halls Creek in Western Australia. The
FIG 18.1 - Percentage metropolitan populations in Australian states
search then moved south, reaching Kalgoorlie by 1893. The
– 1909 and 1999. (Source: Australian Bureau of Statistics.)
discovery and exploitation of gold brought European settlers to
many of our current regions – Central Highlands, Loddon,
Goulburn and Ovens-Murray (in Victoria), Central West (in New A belated parallel development now beginning to emerge is
South Wales), Northern and Far North (in Queensland) and the movement of population back into the hinterland in New
Central and South Eastern (in Western Australia). The final two South Wales and Victoria, the two most populous states. Traffic
regions encompass the Goldfields, the Yilgarn and the Murchison congestion, high housing prices, the impact of technology and
in WA. the malaise of large metropolitan areas may finally now be
Though hardly as glamorous as their gold mining compatriots, reversing what appeared to be an inexorable trend towards
Cornish copper miners had initiated a successful industry in suburban living in the major metropolises.
South Australia in the 1840s. Prospering for three decades, it In the face of these trends, mineral and energy-based regions
provided an early economic base for the colony around Adelaide. have struggled to retain their populations, even though the
Subsequent major discoveries of base metals at Broken Hill and resources sector has been performing well.
Cobar, and at Mount Isa, stimulated regional development in the
remote Far West region on New South Wales, and in North West SOCIO-ECONOMIC INDICATORS
Queensland, as well as in distant metropolitan centres.
Tasmania’s economic prosperity in the final part of the 19th Having established an historical and geographical perspective,
century came in significant part from metals such as copper and some of the broader social and economic impacts of mining, in a
tin. It stimulated long-term development in the Mersey-Lyell and regional context, are considered. The regional definition
Northern regions. implicitly favoured in the preceding discussion is that of the

210 Australian Mineral Economics

 CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT

statistical division (with minor variations) in the Australian BOX 18.1 – THE PILBARA – A COMPARATIVE
context. It is also possible to consider larger or smaller regional SOCIO-ECONOMIC SNAPSHOT AT THE 2001
areas. In their studies of Australian ‘regions,’ many authors and
policy advisors have used, and continue to use, the states and
CENSUS
territories as their units of analysis. Equally it is also possible to The following social and economic indicators provide an
consider regions in a more micro fashion, comparing the social assessment of some of the differences between the structure
and economic fortunes of local government areas with one of a typical mining region and the nation. They are derived
another. One’s level of analysis is a matter of deciding where to from the Basic Community Profile tables from the 2001
draw the ‘ring fence,’ using colloquial public policy jargon. National Census. The dimensions presented are as follows:
One way of appreciating these different levels of analysis in
the Australian context, is to note that there are six states and two Broad Indicator Pilbara Australia Pilbara
internal territories6, 56 substate regions and more than 800 legal dimension as % of
local government areas. Australia
Whenever a mining company considers operating in a region, Demographic Average age (years) 31 35 88.6
it is important to: Cultural Aboriginality (% of 12.7 1.9 668.4
population)
• understand the initial economic and social environment it
faces; and then Social Health/Community 5.7 9.7 58.8
services (% of health
• manage the operation of a new or established mine in a and community
manner acceptable to its occupational, residential and workers )
indigenous communities. Social Residential stability 39.6 55.2 71.7
There is a range of socio-economic indicators potentially (% at same address
available in small areas and regions to appreciate the surrounding as last census)
environment. The main source of these data in Australia is from Socio-economic High school 30.1 40.9 73.6
the national census. At the 2001 census, for example, the ABS graduates (% of
generated data on: adult population)
Socio-economic Internet use (% of 75.4 38.9 193.8
population, age, birthplace, citizenship, education, population)
ethnicity, housing, incomes, employment by
industry, Internet access, indigenous status, labour Economic Participation rate (% 68.3 59.6 114.6
of adult population)
force, language, marital status, motor vehicle
ownership, occupation, qualifications, religion and Economic Income (weekly $1300 $750 173.3
travel to work household income)

for people living and working in these small areas and regions. It
is possible to analyse these data separately or together to assess
differences in economic and social conditions between regions.
Many of these data are now also available for several censuses.
Thoughtful analysis can therefore provide an appreciation of
recent social and economic trends in these smaller regions.
A simple conceptual analysis considering some cultural,
social, socio-economic and directly economic dimensions of a
typical remote resource-rich region (the Pilbara) in comparison
to the nation appears in Box 18.1.
The Australian Bureau of Statistics also produces a range of
summary indicators under the banner of Socio-Economic Indices
for Areas (SEIFA). At the 2001 census it compiled four indexes
in this group (Australian Bureau of Statistics, 2003). These were:
• the Index of Advantage/Disadvantage – a continuum of
advantage to disadvantage… available for both urban and
rural areas… it takes into account variables relating to
income, education, occupation, wealth and living conditions;
• the Index of Disadvantage – derived from attributes such as
income, educational attainment, unemployment and
dwellings without motor vehicles… focuses on low income
earners, relatively lower educational attainment and high
unemployment;
• the Index of Economic Resources – based on variables such
as income, expenditure and assets of families, such as family
income, rent paid, mortgage repayments, and dwelling size;
and
6. Such regional analysis typically overlooks activities in Australia’s
external territories.
7. Observations within two standard deviations of the mean (between
800 and 1200) cover more than 95 per cent of the population.
The population of the Pilbara is younger than the average
for the nation by four years and there are more than six
times as many aboriginal people as nationally. The region
performs well on economic dimensions – areas such as
average incomes and participation rates, there are mixed
results on socio-economic dimensions – education levels
(low) and Internet access (high) – and relatively poorly on
some key social indicators – such as the residential
stability of the population and the percentage of health and
community workers.
Mining has made a positive contribution to the economic
welfare of residents of the Pilbara region, but some of its
social impacts are more open to question. Any definitive
assessment of this should involve comparisons with the
fortunes of other non-metropolitan regions. Such an analysis
may indicate directions for remedial policy.
• the Index of Education and Occupation – based on
variables relating to the educational and occupational
characteristics of communities, such as the proportion of
people with a higher qualification or those employed in a
skilled occupation.
Developed using Principal Components Analysis, each of
these measures provides a standardised normal distribution with
a mean of 1000 and a standard deviation of 1007.
In its promotional brochure, the Australian Bureau of Statistics
(2003) claims that:
SEIFA 2001 has a number of applications for
government, business and research use. For
Local, State and Commonwealth Government
agencies, SEIFA 2001 is an invaluable tool for
helping to determine the allocation of funding
and services. Businesses will find SEIFA 2001

Australian Mineral Economics 211

CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT

extremely helpful for targeting marketing and
promotional campaigns, determining locations
for outlets, and conducting consumer research.
Researchers will find SEIFA 2001 useful in
constructing models involving socio-economic
status.
Lower than average values in a potential mining region might
suggest the desirability of importing workers from other regions
or making strategic investments in key infrastructure or human
capital development. Higher values might be useful in promoting
mining areas as relatively desirable places to live and work.
Estimates of these indices for Australia, Western Australia,
Western Australian regions, and selected mining and non-mining
local government areas appear in Table 18.4. Despite a
traditional image as being less desirable places to live and work,
most mining areas show values of two of these indices:
• the index of advantage/disadvantage, and
• the index of economic resources,
as generally being above the average.
While estimates of the other two indices:
• the index of disadvantage, and
• the index of education and occupation,
are below average; they are generally within one standard
deviation of the mean. Values tend to be lower in small remote
mining towns. The values of all of these indices for mining
compare favourably with parallel measures in other rural regions.
An alternative information source available in some
developing nations is to compare Human Development Index
(HDI) values for local areas and larger regions. Recall from
Chapter 2 that these summary measures are based equally on
income, life expectancy and levels of education. Offices of the
United Nations Development Program in several developing
nations have computed these measures on a regional basis, often
in association with the host country governments. They typically
show low HDI values for remote regions and high values for
affluent areas in the major metropolises. Access to summary
measures such as these can provide a useful initial source of data
for a mining company which is trying to assess the financial
viability and risks associated with developing or purchasing
mines in a developing nation.
By way of example, a student in the University of Chile
Mineral Economics program has recently been working with a
small company on a project to mine limestone for cement in one
of the poorer communes (local government areas) of Southern
Chile. The commune in question was Lonquimay, based around a
small town in Chile’s Ninth region (some 1000 km south of
Santiago). He was concerned about the working environment in
the small region, given its estimated HDI value of 0.618 ranked it
305th in Chile’s 333 communes. The range of HDI values in
Chile’s communes was between 0.565 and 0.924. The national
HDI in 2003 was 0.834. Remember that Australia’s HDI in 2003
was 0.939.
Located at high altitude in the foothills of the Andes close to the
Argentinian border, Lonquimay has been a depressed economic
region. The new mine seemed to offer new development and
income potential for indigenous and non-indigenous communities
alike. Yet its cultural, social and economic profile made it difficult
to attract well-qualified resource sector personnel. Despite the
further questions that a low value for such a measure might
provoke, it provides potential investors with interesting summary
information about the ‘playing field’ in which they will be
operating.
ASSESSING ECONOMIC IMPACTS
Against this background it remains an interesting challenge to
assess the effect of new mine developments on their surrounding
regions. Two broad approaches have emerged. The first is
economic impact assessment, the second the more broadly
focused social impact assessment. The use of each approach has

TABLE 18.4
ABS estimates of socioeconomic indices at the 2001 census. (Source: Australian Bureau of Statistics, 2003.)

Area Index of Index of disadvantage Index of economic resources Index of education and
advantage/disadvantage occupation
Australia 1004.9 1002.1 1009.3 1001.2
Western Australia 1006.8 1003.6 1006.7 998.5
Metro Shires
Perth (City of) 1102.4 1031.5 1055.4 1155.1
Nedlands 1196.8 1130.9 1166.4 1206.5
Key regional centres
Albany 952.6 986.3 934.0 968.2
Mandurah 929.7 949.3 952.4 917.1
Bunbury 957.8 960.1 978.6 947.1
Collie 907.2 925.0 919.5 877.6
Goldfields
Kalgoorlie Boulder 1016.0 986.0 1085.5 951.0
Coolgardie 969.9 934.1 1051.7 888.5
Leonora 1028.9 975.6 1098.3 947.0
Yilgarn 983.5 995.6 995.0 943.1
Pilbara
Port Hedland 1042.5 969.9 1114.6 960.5
Roebourne 1053.3 1002.1 1128.1 960.9
Ashburton 1031.2 983.2 1107.7 935.6
East Pilbara 1010.2 916.0 1067.2 933.4

212 Australian Mineral Economics


been influenced recently by the rise of the sustainable
development concept, with its focus on the triple bottom line –
the economic, environmental and social/cultural changes
associated with such development – over an extended period.
New mineral investment, or the closure of a mine or a mill,
will generate a series of direct, indirect and induced effects on its
surrounding regional economy. An active exploration program,
followed by the building and operation of a mine, concentrator,
smelter or refinery will directly provide income and jobs for
workers living nearby. Local firms will typically also supply
transport and commercial services for the mine or mill – an
indirect impact. Also the arrival of a large mine in a region will
generate a larger demand by the workers for health, education,
better shopping, entertainment and a variety of other services.
Analysts typically describe these as induced effects.
Regional scientists and economists have been responsible for
developing a range of techniques to estimate the multipliers
(measuring the total impact on a region of a small increment or
decrement to investment) associated with new resource
investment or the closure of a mine. Analysts have used:
• economic base analysis,
• Keynesian income-expenditure models,
• regional econometric models,
• input-output models, and
• computable general equilibrium models.
to estimate the size of income, output and employment
multipliers associated with these investments.
The nature of these models varies from the rather simplistic
economic (or export) base models, from which one can quickly
estimate indicative multipliers, through to input-output models
(sometimes complemented with computable general equilibrium
models) that may be expensive to build but which provide a
broader range of more complete multiplier estimates.
It is beyond the scope of this volume to review these
techniques in detail, but authors such as Armstrong and Taylor
(2000) and Hoover and Giarratani (1984) provide interesting and
readable introductions to them, discuss the ways in which they
are estimated and consider their limitations.
While the initial direct impacts on a small region of mineral
investment may be substantial, the size of the multipliers
associated with investment in small areas tends to be low. This
arises particularly because of the weak backward and forward
linkages of mines or oil wells into local economies. Hence the
income multiplier from a new mine near Mount Isa on the North
West region in Queensland may only be 1.3. Its impact on the
Queensland economy might be larger, say 1.6.
In an input-output study of the Western Australian economy,
commissioned by the Chamber of Minerals and Energy of
Western Australia, Clements and Ye (1995) generated the
following estimates of output, income and employment
multipliers for various mining and mineral processing activities
for Western Australia.
Output Income Employment
Mining
Metallic minerals 2.1 3.0 4.1
Coal, oil and natural gas 1.8 2.2 3.6
Services to mining 3.0 3.1 3.2
Mineral processing
Basic metal products 2.3 3.4 4.7
Chemical, petroleum and 1.9 3.8 4.3
coal products
Average for all sectors of 2.2 2.4 2.6
WA
Australian Mineral Economics
CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT
The size of these estimated multipliers seems relatively high.
This must be due in part to the size of the region and the fact that
there are fewer income leakages from it than from a small region
such as a remote mining town or a fly-in, fly-out mining camp.
ASSESSING SOCIAL IMPACTS
The origins of the social impact assessment (SIA) are from the
discipline of sociology. The technique, which has evolved since
the 1970s, emerged as a by-product of the environmental impact
assessment process. Practitioners also now apply the technique in
its own right in a variety of countries to new resource projects.
A simple definition of SIA is:
The process of assessing or estimating, in
advance, the social consequences that are likely
to follow from specific policy actions or project
developments. (Interorganizational Committee
for Guidelines and Principles for SIA, 1994).
In compiling a set of guidelines for its more consistent use, the
ICGP suggested the following stages in its application:
• alternatives identification;
• baseline data collection;
• issues scoping;
• prediction of impacts (direct, indirect, induced, cumulative);
• development of mitigation measures; and finally
• the design of monitoring and audit procedures.
Joyce and MacFarlane (2001) note its advocacy by the
European Union, and its requirement in association with
environmental impact statements by the US Council on
Environmental Quality. It is also used in Canada. The World
Bank (and some NGOs) utilise its principles.
In commenting on its application, they state that:
The underlying tension that cuts across all of the
issues associated with Social Impact Assessment
is the difference between its potential (currently
realised in a small percentage of projects) and its
general current use. The difference can be
extreme. At one end, the SIA is a dynamic,
ongoing process of integrating knowledge on
potential and real social impacts into
decision-making and management practices; at
the other end, it is a static, one-shot technocratic
assessment undertaken to gain project approval
or financing, with little or no follow through.
Most SIAs fall somewhere along a continuum
between the two.
While reference to social and economic impacts tends to be
associated with environmental impact assessments for proposed
new resource sector projects in Australia, the systematic use of
SIA as an integrative tool to assist management has been limited.
Its application has been more of the ‘one-shot technocratic’
variety that other more active versions in which monitoring and
revision takes place during the life of a project.
Yet, as has been argued earlier, mining has been historically
associated with the significant development of the Australian
hinterland throughout its European settlement. The introduction of
active and dynamic formal social impact assessment techniques
would require greater political and community will. If this
happens, as we have seen, the Australian Bureau of Statistics
provides a range of social and other statistics to assess this.
FLY-IN, FLY-OUT AND REGIONAL
DEVELOPMENT
As noted in Chapter 8, the rise of fly-in, fly-out work patterns has
made a significant difference to the lifestyles of many Australian
213
CHAPTER 18: MINERALS AND REGIONAL DEVELOPMENT
mining professionals. Rather than having their families live close
to mines in small remote towns such as Mount Magnet, Moranbah,
Tennant Creek, Newman, Leonora or Kambalda, growing numbers
fly-in and out (or drive in and out) to work on a variety of rosters
from big cities like Perth and Brisbane, or large regional centres
such as Mackay, Townsville and Cairns.
The evolution of work rosters has been making modern fly-in,
fly-out mining professionals more and more like commuters to a
Central Business District from dormitory suburbs. The individual
and their families spend most of their incomes in the areas where
they live. While on the job in their 9/5 or 5/2/4/3 rosters,
professionals spend little and employers typically deposit their
salaries into a local bank account. The towns in the remote
regions where they work see less and less of the income that they
make. The income, output and employment multipliers from
such projects in these regions has recently been in decline.
In his paper on Western Australia, Storey (2001b) perceives its
impact on regions in the following terms:
• companies benefit from resources in the regions but, by
basing their workforces in Perth, give little back to those
regions;
• businesses in the regions fail to benefit from FIFO as most of
the benefits go to service and supply companies in Perth;
• FIFO arrangements harm the regions by contributing to
population decline and associated federal grant decreases,
and negative business decisions such as the closure of bank
branches.
While state governments can frame policies which partially
influence these issues, the costs of doing so is likely to be high.
Accepting market-driven behaviour from companies operating in
a global industry has often seemed easier to tolerate than framing
policies that might drive them offshore.
In states such as Western Australia, there are many worthy
claims on royalty and tax revenue from mining activities – both
inside and outside mining regions. Even though these revenues
generated by mining will typically finance active regional
policies in mining regions, political decision-makers typically
choose to spend the proceeds more broadly. The justification of
such decisions will depend on value judgments arising from their
particular ideologies. Commitment to a sustainable development
strategy may, for example, see the development of services such
as health, education, transport and communications infrastructure
or other emerging industries more appropriate for the long run
than strong support of mining regions.
While fly-in, fly-out is significant from larger cities in Western
Australia, Queensland and the Northern Territory, it is less
important in states such as New South Wales and Victoria. In
these areas, mining workforces reside more often in surrounding
regional towns. The size and congestion in major metropolitan
centres such as Sydney and Melbourne, has apparently pushed
the balance in favour of regionally based workforces for mines
such as Cadia, Cowal and Girilambone. When cities such as
Perth and Brisbane become larger and more congested, their
attractiveness for workforces and companies may well subside.
214
In the mean time, there are some policy initiatives that may
assist regional centres to become more attractive to mining
company workforces and therefore enhance regional
development. Perhaps most important in this area is ensuring that
such centres have good quality schools, hospitals and other
health services and recreational facilities available and also
ensuring that transport and communications frameworks are
strong and competitive. If these facilities are in place, the
decision to locate a mining company’s workforce in a town or
district becomes much easier. It also makes the services that local
businesses provide much more competitive.
REFERENCES
Armstrong, H and Taylor, J, 2000. Regional Economics and Policy, third
edition (Harvester Wheatsheaf: New York).
Australian Bureau of Statistics, 2002. Census of population and housing,
2001 (Australian Bureau of Statistics: Canberra) [online]. Available
from: <http://www.abs.gov.au>. Date accessed: 8 May 2006.
Australian Bureau of Statistics, 2003. Socio-economic indexes for areas
2001: A comprehensive profile of the Australian people (Australian
Bureau of Statistics: Canberra) [online]. Available from:
<http://www.abs.gov.au>. Date accessed: 8 May 2006.
Australian Bureau of Statistics, various years. Year Book Australia
(Australian Bureau of Statistics: Canberra). [online]. Available from:
<http://www.abs.gov.au>. Date accessed: 8 May 2006.
Blainey, G, 2003. The Rush That Never Ended, fifth edition (Melbourne
University Press: Melbourne).
Clements, K and Ye, Q, 1995. A New Input-Output Table for Western
Australia (Economics Research Centre, University of Western
Australia: Perth).
Hoover, E and Giarratani, F, 1984. An Introduction to Regional
Economics, third edition (Alfred A Knopf: New York).
International Institute for Environment and Development (IIED), 2002.
Breaking New Ground, local communities and mines, Chapter 9,
Mining, Minerals and Sustainable Development – The report of the
MMSD Project (Earthscan Publications: London) [online]. Available
from: <http://www.iied.org/mmsd/mmsd_pdfs/finalreport_09.pdf>.
Date accessed: 8 May 2006.
Interorganizational Committee for Guidelines and Principles for SIA
(ICGP), 1994. Guidelines and principles for social impact assessment
(US Department Commerce: Washington).
Joyce, S A and MacFarlane, M, 2001. Social impact assessment in the
mining industry: current situation and future directions, Mining,
Minerals and Sustainable Development project Report No 46,
December (International Institute for Environment and Development:
London) [online]. Available from: <http://www.iied.org/mmsd/
mmsd_pdfs/social_impact_assessment.pdf>. Date accessed: 8 May
2006.
Maxwell, P, 2004. Mining and sustainable communities – a Western
Australian perspective, Sustaining Regions, 3(2):19-28.
Moore, G, 1998. Mining Towns of Western Australia (Chamber of
Minerals and Energy: Perth).
Storey, K, 2001a. FIFO mining in Australia: what do we really know
about its social and economic impacts? mimeo, November, 22 p.
Storey, K, 2001b. Fly-in/fly-out and fly-over: mining and regional
development in Western Australia, Australian Geographer,
32(2):133-148.
Australian Mineral Economics
NAME INDEX

Index Terms Links

Adams, M H 114
al Rawashdeh, R 23
Altman, J C 197 198
199 201
Amos, Q G 96 114
Andrews, C B 158
Antikarov, V 142 143
Armstrong, H 213
Atkinson, G 22
Auty, R M 17 22 24 157
192 193

Bailey, S 46
Baker, M P 140
Bedworth, D B 3
Belanger, D 45
Benninga, S Z 131 143
Bernard, J-T 45
Biddle, N 197
Black, F 143
Blackshield, T 162
Blainey, G 8 12 14 77
199 208
Bolduc, D 45
Bonnici, J 1 153
Bourassa, M J 99
Bradley, P G 137 179 180
Brady, B 81
Brealey, R 89
Brennan, M 145
Brennan, T 45
Brown, R 88 90
108 109 142

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Index Terms Links

Brunetti, C 20
Burger, J 195
Burn, R G 133
Butler, P 123
Butlin, N G 14 197

Calzada, M 175
Campbell, G A 40 42 47
Casassus, J 145
Chavez-Martinez, M L 51
Christie, M A 122
Claeys, J 148
Clements, K 213
Clunies Ross, A 20 155 174
Connell, J 199
Coombs, H C 196
Copeland, T 140 142 143
Corden, W M 20
Corbett, B 45
Corbett, T 204
Cordes, J 193
Cortazar, G 145
Costelloe, D 45
Cousins, D 199
Craven, G 162
Crommelin, M 175
Crowson, P 32 54 57
Cueller, S S 46
Curson, P 197
Cusworth, N 116 117 120
Czelusta, J 15

Davis, G A 14 17 22 23
24
Deer, P W 93 97
Denolder, T 175
Dias, M A G 138
Dillon, M 199 201 202

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Index Terms Links

Dinham, N 148
Dixit, A K 140
Dodson, M 196
Drucker, P F 47
Dulay, N 42

Easton, S 88 90 108 109

142
Eggert, R G 17 18 190 193
Ericsson, M 53
Eriksson, R 44
Espey, M 47
Etheridge, M 93 136 137

Faiz, S 148
Flores, V 148
Fuerbringer, J 39

Galbraith, J K 1 20 21 154
155 174
Garnaut, R 3 20 21 154
155 174
Gelb, A H 17 22
Giarratani, F 213
Gilbert, C L 20
Gilfillan, J F 114
Gove, P B 195
Grubel, H G 28
Gruen, D 45
Grytten, J 44
Guzman, J I 47
Gylfason, T 22 23

Hall, B 79 82 183
Hamilton, K 22

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Index Terms Links

Hanneson, R 191 192

Harris, D P 51
Hartwick, J M 176 181
Harvey, B 201
Hayward, N 134
Heilbroner, R 1
Hicks, J R 43
Hilson, G M 75 76 77
Hirsch, P 199
Hirshleifer, J 93
Hocking, A 1 153
Hoover, E 213
Horrigan, B 203
Horton, D R 196
Hotelling, H 50 173
Howard, P 88 90 108 109
142
Howie, P 50
Howitt, R 197 199 200 203
Hughes, H 181 182 184
Humble, L 39
Humphreys, D 45
Hunter, B 197 198 201

Jeffrey, W 7 12
Jevons, W S 1 50
Joyce, S A 213

Kandelaars, P 47
Keenan, P T 140
Krautkraemer, J A 50

Laird, A M 113 115 125

Lane, P H 162 168
Langton, M 199
Laughton, D G 138 145

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Index Terms Links

Lawrence, M J 99 100
Lawrence, R 204
Lawrence, R D 141
Lederman, D 22 23
Lesley, K J 148
Lord, D 136
Lundgren, N-G 32

Mabo, E 165 203

MacFarlane, M 213
MacKenzie, B 1 2 4 49
50
Maddison, A 14 23
Maloney, W 22 23
Mangan, J 83
Manning, W G 44
Maponga, O 15 18 81 158
Marshall, A 1 43
Mason, A 203
Maxwell, P 1 15 18 24
25
81 153 158 209
Mayfield, E S 140
McCardle, K 148
McCracken, K 197
McDivitt, J 7 12
McLean, I 14
Meadows, D 50
Michaels, M P 148
Mikesell, R F 192 193
Mill, J S 37
Miller, M H 97
Mitchell, G D 41
Modigliani, F 97
Moore, G 209
Morgan, J P 148
Mun, J 141 142 143 144
145 147
Myers, S 89

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Index Terms Links

Nankani, G 17 22
Nieuwenhuysen, J 199
Northcote, A E A 115 125

O’ Faircheallaigh, C 204
O’ Hare, C W 175
Olewiler, N 41
Otto, J M 156 158 193

Palmer, L 199
Parson, J E 140
Pei, F 45
Peirson, G 88 90 108 109
142
Pezzey, J C V 193
Phelps, C E 44
Pindyck, R S 140
Portney, P R 188
Poulin, R 145

Radetzki, M 157
Randall, A 153
Ranhawa, S U 3
Rappaport, A 91
Ricardo, D 27 173
Riggs, J L 3
Robbins, L 1
Rogers, P H 199
Roscoe, W E 100
Ross, M 22
Rozman, L I 123 125
Rumsey, A 199

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Index Terms Links

Sachs, J 22 23
Salahor, G 110 137 138 140
Samis, M R 137 140 145
Schanz, J J, Jr 3
Schodde, R 133
Scholes, M 143
Schwartz, E 145
Seymour, C 123
Shain, K 199
Shaw, A G L 12 13
Shillabeer, J H 115
Shuetrim, G 45
Sibbel, A 83
Sinclair, W 12 13
Singh, S 182
Sirower, M L 91
Slade, M E 20 146
Smith, A 1 63
Smith, B 182
Smith, J 148
Solow, R W 173
Stewardson, R 30
Stirzaker, M 124
Storey, K 82 83 209 214

Takashi, N 47
Taylor, H K 102
Taylor, J 213
Tehan, M 199
Tilton, J E 12 45 47 49
50 51 52 54
56 57 155 176
189
Todaro, M 10
Toman, M A 193
Torries, T F 100 103
Torvik, R 23

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Index Terms Links

Trench, A 89 93

Uttley, P 93 136 137

van Dam, J D 47
Veneroso, F 45
Venkatesh, R 44

Walkup, G 148
Ward, I 1 153
Warden-Fernandez, J 195
Warner, A 22 23
Waud, R N 1 153
Webb, A 193
Webb, M 193
Weber-Fahr, M 24
Weiner, J 199
Weyant, J P 188
Wheelwright, K 163
White, M E 115
Williams, G 162
Wilson, A J 12
Woodward, Justice 202
Wright, G 15

Ye, Q 213
Yeates, G 114
Young, H P 190 191

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SUBJECT INDEX

Index Terms Links

Aboriginal Australia
historical background 196
interface with mining 199
Aboriginal Heritage Act 1972,
Western Australian 167
Aboriginal Land Rights Commission 1974 202
above normal profits 61
accounting profit 172
accounting treatment of mineral reserves and
resources 104
accrual accounting 104
administrative cost, taxation and 176
amortisation 104
annual equivalent value (AEV) 108
appraised value 100
appropriate period break-up 101
Argyle
Dillon’s study of 201
fly-in, fly-out at 201
assumed certainty 101
Australian Constitution
allocation of powers 161 174
validity and consistency under Section 109 168
Australian gold rushes 13
Australian mining in 20th century 14
Australian mining operations, companies and
joint ventures 77
Australian mining
employment and value added 77
fly-in, fly-out work pattern growth 82
gender imbalance 80
location of employees 79
occupational and educational structure 79
salaries and wages 78

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Index Terms Links

Australian mining (Cont.)

shortage of professionals 81
Australian mining workforce 77
historical trends 77
authoritarian rule 1

backwardation 71 183
balance of payments 33
bankable feasibility studies 117
barriers to entry
falling and decline of monopoly power 62
low 59
raised 60
benefits, marginal and total 38
binomial distribution 130
binomial lattice method 142
Black and Scholes (B-S) formula 142
Breaking New Ground 207
bridging finance 95
buying and selling pressure 39
by-product mineral supply
determinants 54
examples in Australia 54

capital study of 7
capital asset pricing model (CAPM) 94
capital assets 104
capital budgeting 87
capital costs, components of 119
capital efficiency index 103
capital expenditure, tax deductibility of 182
cartels 63
history of mineral 63
preconditions for successful 64
rise and fall of international producer groups 64
cash bidding, as mineral taxation 180
cash clearing 69
cash costs 57 58 59

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Index Terms Links

cash flows of a mining project 121 129 138

certainty equivalent (CX)
checklist, feasibility study 126
Chile, development experience 24
civil wars 22
closed-form equation 142
commodity (gold)/derivative loans and advance
sales 95
common law 161
community indifference curve 153
company income tax 182
comparable sales valuation 100
comparative advantage 27
comparison of mutually exclusive projects with
different lives 107
competitive markets 59
competitive policy regimes, ingredients of 159
computable general equilibrium models 213
concentration in mineral markets 60
conditional (Bayesian) probabilities 134
consumption 8
contango 71 183
contingency allowed in feasibility study 120
continuous time discount factor 144
contributory shares 90
copper cartel (CIPEC) 64 65
co-product mineral supply, determinants 55
corporate bonds 95
corporate finance services 88 94
corporate objectives 100
corporations power, under Australian
Constitution 162
corruption
HDI index and 21
perceived 21
cost function 102 97
cost of debt (RD) 94
cost of equity (RE)
weighted average cost of capital (RC) 104
customer finance 95

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Index Terms Links

cut-off grades 122

DCF model
in nominal money terms 106
in real money terms 107
dealer markets 68
debentures 95
debt 89 104
debt service ratio 96
decision nodes 134
decision trees 134
demand curve
consumer tastes and 39
created 37
derived 37
expectations and 39
final product 37
historical 37
income and 39
individual 38
law of 39
market 38
shifts in demand 39
depreciation 104
derived demand 37
for minerals 39
Hicks-Marshall laws of 43
developed nations, classification 16
developing nations, classification 16
development 10
diamond cartel, De Beers and 65
discounted pay back period 103
discounted cash flow (DCF) 100
discounting and sustainable development 188
disruptive events, as determinant of mineral
supply 52
distribution 7
social justice and 189
diversified portfolio effect 87

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Index Terms Links

down factor 143

Dutch disease 20 189

economic base analysis 212

economic development 10
economic efficiency 155
taxation and 175
economic equity 155
economic growth 9
economic policy
aims of 153
practice of 153
economic rent 172
pursuit of 174
scarcity and 173
taxes designed to capture 176
economic sustainability, and mineral policy 189
economically rational investor 93
economics 1
education, Aboriginal Australian 198
elasticity of mineral demand
cross price 46
income 45
long run 46
own price 42
elasticity of supply 54
employment in mining, Aboriginal 199 202
engineering economics 3
environment 7
environmental laws, external affairs power and 164
Equator Principles 193
equilibrium
market 39
mineral market 41
equity 89 104
equity, taxation and 176
exchange rate policy 154
exchange rates
and mineral prices 34

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Index Terms Links

exchange rates (Cont.)

and producer pricing 67
as determinant of mineral supply 52
fixed or floating 33
mineral trade and 33
trade weighted index 33
expanded net present value (ENPV) 142
expansion option 144
expected monetary value (EMV) 129 134
exploration licences, Western Australian 166
exploration spending
positive externalities and 183
tax deductibility of 182
export levies, as minerals taxation 180
export power, under Australian Constitution 163
external affairs power, under Australian 164
Constitution
externalities
negative 175 191
positive 183
external market forces 19
Extractive Industries Review, World Bank 192 194

factor 143
fairness to current and future generations 188
farm-in/farm-out stages 93
farm outs/joint ventures 90
feasibility studies
objectives of 114 117
reports 125
types of 115
few producers
effect on prices 60
market demand and 61
final product 37
finance lease 95 108
financial leverage 88 97 105
financial planning 88
financial risk 88 97 101

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Index Terms Links

financial structure 88 97
financing decision 101
(also see funding decision) 88
fiscal policy 154
fixed costs 57
flow-through shares 92
fly-in, fly-out
regional impacts of 213
work patterns 82
formal mining sector 75
forward contract price 132
Fraser Institute survey of mining executives 156
frequency distribution 136
fundamental financial accounting equation 88
fundamental or technical valuation 100
fundamental value 91
funding decision 88
(also see financing decision) 101

geological endowment
nature of 2 49
geometric Brownian motion (GBM) 139
Global Compact 193 194
Global Mining Initiative 192
government activities, as determinant of mineral
supply 52
government equity participation 180
government, functions of 153
government philosophies 190
Gross Domestic Product (GDP) 9
estimates 18
growth of 28 72
limitations of measure 10
mineral contribution to 18
per capita at PPP 9
recent growth and metal usage 72
group accounting 88

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Index Terms Links

health, Aboriginal Australian 196

Heckscher-Ohlin-Samuelson model 28
hedging, taxation and 183
home ownership, Aboriginal Australian 198
horizontal equity 176
human activity versus carrying capacity 188
Human Development Index (HDI) 10 188
hybrids 89

idiosyncratic, unsystematic or unique risk 93

immediate run 49
income, Aboriginal Australian 198 201 202
income based valuation, cost based valuation 99
income distribution 154
independent reports, required in feasibility
studies 118
indigenous people
definition 195
interests of 195
locations of 195
population 195
Industrial Relations power
under Australian Constitution 163
under Western Australian law 163
initial public offerings (IPOs) 90
input costs, as determinant of mineral supply 52
input-output analysis 213
institutions and mineral development 189
intergenerational equity 176
internal economic stresses 20
internal rate of return (IRR) 103
International Bauxite Association 64 65
International Council on Mining and Metals (ICMM) 192
international trade
distribution of 29
factors affecting 28
growth of 28

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Index Terms Links

investment 8
investment decision 87 101
investor relations 88
issues of scale, with sustainability 188
iterative nature of feasibility studies 115

Joint Ore Reserves Committee (JORC) 51

joint venture proper stage 93
joint venture terms valuation 100
JORC code 99 118
reporting reserves under 117

Kaldor-Hicks criterion 155

Keynesian income-expenditure models 213

labour 7
land 7
large mining companies and small economies 158
law, meaning of 162
‘learning by doing’ 20
legal and regulatory framework, managing 153 154
life expectancy, Aboriginal Australian 198
liquidity 88
list prices 68
loan life ratio 96
local communities, benefits of mining to 190
log-normal distribution 111
London Metal Exchange (LME) 68
basic contract 69
contracts 68
hedging in 69
history 68
options in 69
registered warehouses 70
warehouse inventories 73
long run 49

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Index Terms Links

Mabo judgement of Australian High Court 165 195 203

as determinant of mineral supply 53
macroeconomics 2
management flexibility 140
marginal benefit curve 38
marginal physical product (MPP) 40
marginal revenue product (MRP) 40
marketable debt papers 95
marketable long-term debt papers 95
market-based valuation 99
market demand curve
final product 38
mineral 40
market equilibrium
in competitive markets 59
in oligopolistic markets 61
market portfolio 93 93
market premium (RM - RF)
market/price risk 101
market structure, as determinant of mineral
supply 53
market surveys 121
market system 1
maximisation rule 145
mean 130
microeconomics 2
Mine Safety and Inspection Act, Western Australian 166
Mineral Council of Australia, Enduring Value
project 192
mineral demand
elasticity of 42
prices of substitutes and complements and 42
shifts in 41
technology and 41
mineral dependent nations 17
mineral development, public approval processes 191
mineral economics
defined 1
key questions 4

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Index Terms Links

mineral demand (Cont.)

practice of 4
mineral endowment, institutions and government 24
policy
mineral markets, recent trends 72
mineral policy
attractiveness of 157
context of 154
dimensions of 189
economic sustainability and 189
in practice 155 156
transition since 1950 156
mineral production
Australian 30
environmental quality and 188
physical sustainability of 188
world 28 29
mineral products, homogeneity of 60
mineral rents 191
mineral reserves 51
Australian 30
mineral resource, determining a project’s 114
mineral resources 51
mineral revenue policies, future 183
mineral royalties and taxes 104
mineral sector, size 2
mineral supply
by-products 51
co-products 51
curve 50
during different time periods 54
individual and main products, determinants 51 52
process 50
total 57
mineral taxation
current regimes in Australia 176
design principles 175
evaluation of Australian system 181
less orthodox methods 177
power to raise 175

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Index Terms Links

mineral trade
Australian exports 31
international 29
mineral endowment and 32
minerals and economic development
factors affecting 18
traditional view 12 15 18
minerals and history 12
minerals, standard classification of 3
mines, characteristics of 3 154 155
Mining Act 1978, Western Australia 166
mining
and Australian regional development 210
and economic sustainability, factors affecting 189
and sustainability in practice 192
and sustainable development, traditional view 189
mining, distributing proceeds 191
mining economics 3
mining, environmental sustainability and 188
mining leases, Western Australian 166
Mining, Minerals and Sustainable
Development Project (MMSD) 192 193
mining operations, factor intensity in 75
mining towns, Australian 208 209
mining workforce
artisanal and small scale 76
estimated size in 2001 76
in developed nations 75
in developing nations 75
in transition economies 75
modern asset pricing (MAD) 137
monetary policy 154
monopolies
effect of growing demand on 62
effects of quotas and tariffs on 62
local 62
objectives of 61
pricing and 62
Monte Carlo simulation 111
multiple of exploration expenditure valuation 100

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Index Terms Links

multiple or chooser option 141 145

multipliers, mining investment 214

native title 195

Native Title Act 1993 165 203
Native Title Amendment Act 203
native title claims, mining tenements and 165
native title legislation 165
natural capital 8
negotiated agreements, trend towards 204
negotiated prices in mineral markets 62
net present value (NPV) 103 122
net smelting return (NSR) 103
new scrap supply
defined 55
determinants of 56
New York Mercantile Exchange (Nymex) 68 71
no-arbitrage (one-price) principle 137
nominal money terms 101
non-renewable resources 8
normal profit 172

off-market placements 90
oil, recent demand growth and prices 73
old scrap supply
defined 55
determinants of 56
oligopolies
defined 61
oligopolistic markets 60
oligopsonies, defined 61
one-price principle 137
operating costs, estimation of 120
operating lease 108
option scenario tree 141
options 90
ordinary shares 90
Organisation of Petroleum Exporting Countries

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(OPEC) 63
overdrafts 95
own price, as determinant of mineral supply 52

Pareto optimality 155

pay back period 103 122
phases of a mining project 114
pipeline licence fees, as mineral taxation 180
political geography, changing 17
pooled development funds (PDFs) 92
population, Aboriginal Australian 196
portfolio decision 101
prefeasibility studies 116
preference shares 90 95
present value (PV) 103
price of risk 110
price takers 59
price wars 62
prices, recent rises in mineral 73
pricing
long-term contracts 63
short-term contracts 63
private ownership of mines, swing back 158
probabilistic models 101 111
probability of survival 130
probability or event nodes 134
proceeds of mining, principles of investment 191
producer pricing in mineral markets 62 66
average costs and 66
competition policy and 67
excess capacity and 67
exchange rates and 67
history in major non-ferrous metals 67
nationalisation and 67
stability of 66
trade liberalisation and 67
production 7
production function 7 39 75
production possibility curve 153

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profit and loss statement 105

profit maximisation 61
project base case 101
project cost estimates, definitive 118
project finance 94 95
project life ratio 96
project optimisation 122
project risk 101
public ownership, rationale 157
public policy
facilitating market activities 190
net social benefits of 191
principles and concepts 190
promoting efficiency 190 191
Purchasing Power Parity (PPP) 9 11

quasi-rents 174

race power, under Australian Constitution 164

rail freight rates, as mineral taxation 180
real money terms 101
real option 129
real option valuation 100
real option value (ROV) 91 138 140 142
recycling 2
extent of mineral 55
regional impacts of mining, dimensions 207 208
regions, Australian 209 210
relevant range 111
remoteness, and mining operations 199
renewable resources 8
rent
differential 173
economic 20 172
generalised 173
location 174
mineral 20
monopoly 174

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replicating portfolio 137

replicating portfolio method 143
resource allocation as policy activity 154
resource curse hypothesis 22
resource rent tax 175 177 181
hybrid 180 93
return on the market portfolio (RM)
revenue function 102
risk 130
risk-and-time-adjusted discount rate 109
risk assessment and management 88
risk-averse criterion 130 134
‘risk-free’ probabilitymethod 143 93
risk-free rate of return (RF)
risk management 129 131
risk, managing 125
risk-neutral criterion 130
risk neutralisation 138
risk of gambler’s ruin 130
risk premium 93
risk spreading through joint ventures 133
risk tolerance 129
risk tolerance coefficient (RT) 132
risk underpinning 96
risks
associated with feasibility studies 123
financial and marketing 124
mining and processing 123
project design and construction 124
resource base 123
Roebourne, Howitt’s study of 199
royalties
ad valorem 177 181
origin of term 172
profit-based 177 181
specific 177 181
royalty-based finances 90

saving 8

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scenario analysis 111

scoping studies 115
secondary materials, recycling 55
seed and venture capital 89
selling price of a risky investment 132
sensitivities
associated with feasibility studies 123
project 124
sensitivity analysis 111
sequential/compound option 141 145
short run 49
single option 141
small regions, taxonomy of 207
social impact assessment (SIA) 213
social justice, mining and 189
social justice philosophies, Aristotle, Bentham
and Rawls 191
socioeconomic indicators 210 212
Human Development Index 212
SEIFA 211
solvency 88
sources and application of funds (cash flow)
statement 88 105
sovereign risk 97 176
special agreement acts, Western Australian 166
specialised listed investment companies (LICs) 92
spider diagram 111
stability in revenue flow, taxation and 176
stakeholders in resource sector investments 196
standard deviation classical or objective
probability 130
state and federal laws, inconsistency between 162
state legislation and mining, the Western
Australian situation 166
state mining enterprises 67
state ownership of mining
Auty model 157
efficiency of 157
Radetzki model 157
state prices method 143

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statute law 161

stochastic (probabilistic) models 139
stock market indices 92
subjective probabilities 136
substitute goods 38
supply curve
market 38
by-product 55
sustainability
economic 187
environmental 187
social and cultural 188
sustainable development, dimensions of 188
swaps 94
systematic or market risk 93

tariff policy 154

tastes, consumer 39
tax base 176
tax rate 176
tax services 88
taxation, different treatment of mineral sector 171
Taylor’s formula 102
technological change, as determinant of mineral
supply 52
ten point plan 203
terminal markets 60 68
functions of 68
terms of trade 19
tornado diagram 111
trade 8
international and interregional 27 28
neoclassical theory 28
reasons for 27
trade-offs, price, quantity and quality 62
tradition 1
transfer prices 66
transparency, taxation and 176
transport cost market value curve 32

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transport costs, mineral trade and 31

treasury operations 88
types of real options 140

unemployment, Aboriginal 198 201 202

unsecured convertible notes 95
unsecured notes 95
uranium mining, export power and 164
urbanisation, Aboriginal Australian 198
utilitarian philosophy 37
utility function 132

VALMIN code 99 118

value adding 30
value additivity principle 137
value at risk (VAR) 131
value consistency principle 137
value to weight ratio 31
valuing tonnage-grade trade-offs 145
variable costs 57
vertical integration 29
very long run 49
mineral supply in 50
volatility 140
estimates using the logarithm present value
approach 143
estimates using the management assumption
approach 143
estimates using the market proxy approach 143
mineral price 19

wages policy 154

wealth distribution 154 97
weighted average cost of capital (RC)
Wik judgement of Australian High Court 165 203
World Phosphate Institute 64 65

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yardsticks valuation 100

zinc cartel, demise of 65

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