Financial analysis: closing the loop in valuing mining geology

P Collier1, B Sommerville2 and M Berry3

1.Principal Advisor – Mine Geology, Rio Tinto, Brisbane Qld 4000, perry.collier@riotinto.com
2.Manager Resource Geology and Metallurgical Development, Rio Tinto Iron Ore, Perth WA 6000,
bruce.sommerville1@riotinto.com
3.Director and Principal Geologist, Derisk Geomining Consultants Pty Ltd, Red Hill Qld 4059,
mark@deriskgeomining.com

ABSTRACT
The role of the mining geologist is critical in ensuring the expected financial outcome generated by
the extraction of a mining company’s key ‘asset’ - the orebody – is realised or exceeded. However,
mining geologists’ awareness of the fundamental financial concepts that drive the mining industry
are often limited.
Mining geologists receive a scientific education that rarely includes the study of mineral economics,
financial evaluation and modelling principles, and the tools used by company management to rank
and prioritise investment decisions. Consequently, many geologists face a severe disadvantage
when it comes to preparing a justification and financial analysis for an investment in mining geology.
In contrast mining engineers and metallurgists are well versed in financial analysis and routinely use
this methodology to justify investment in a competitive funding environment.
This paper introduces some of the financial analysis tools widely used in the minerals industry to
analyse and rank investment opportunities across the board, and explains why it is important for
geologists to have a good understanding of these principles. Examples are presented to show how
geologists can incorporate simple financial analysis into their justifications for new capital
expenditure and annual operating budgets.

INTRODUCTION
The wealth of a mining company’s shareholders is increased by maximising the value of the
company itself. This is achieved by diligently investing the money (capital) entrusted to it by its
investors in the acquisition and operation of profit-generating assets. The role of the mining geologist
is critical in ensuring the expected financial outcome generated by the extraction of a mining
company’s key ‘asset’ – the orebody – is realised or exceeded. However, many mining geologists’
have limited awareness of the fundamental financial concepts that drive the industry.
Mining geologists receive a scientific education that rarely includes the study of mineral economics,
financial evaluation and modelling principles, and the tools used by company management to rank
and prioritise investment decisions. Consequently, many geologists face a severe disadvantage
when it comes to preparing a justification and financial analysis for an investment in mining geology;
for example, additional staff, exploration or infill drilling programs, grade control functions or new
technology. In contrast mining engineers and metallurgists are well versed in financial analysis and
associated risk management and routinely use this methodology to justify investment in a
competitive funding environment.
From the shareholder’s perspective, considering all investments (both capital and operational spend)
is critical to the company’s financial performance. At the corporate level a company may, as an
alternative to investing in a project, return money to its shareholders allowing them to invest their
money elsewhere. At the operational level technical personnel, such as mine geologists, will
‘compete’ for project funding under capital and operating budget constraints. For example, ten
projects might be under consideration, and given a limited capital budget, how does a manager
determine which project or projects to develop? Where is this money best invested so as to maximise
shareholder returns? This process of evaluating project options and allocating capital is known as
capital budgeting (Crundwell, 2008, p. 21).
Notwithstanding its pros and cons (e.g. Feinstein and Lander, 2002; Guj, 2013b; Guj and Garzon,
2012; Lilford, Maybee and Packey, 2018), Net Present Value (NPV) remains both the mining

Mining Geology 2019 / Perth, WA, 25-26 November 2019 237

industry’s primary metric for project evaluation and the fundamental basis for the wider range of
project evaluation techniques employed in industry (Guj, 2013a).

FUNDAMENTALS OF FINANCIAL ANALYSIS AND MODELLING

Sources of Corporate Finance

Acquisition of cash flow-generating assets (e.g. mines, mining equipment and plant infrastructure)
requires capital, which is raised from two main sources:
Debt capital (from debt-holders)
Equity capital (from shareholders)
Money does not, indeed, grow on trees, thus the providers of capital demand a certain return on their
investment - debt and equity capital comes at a cost.
The cost of debt is relatively simple – debt-holders (lenders) are rewarded for their investment risk1
by receiving regular payments in the form of interest on the loan. Thus the cost of debt is the interest
rate, adjusted for the tax rate (because interest is tax-deductible).
The cost of equity is more complicated. Shareholder equity is the money that shareholders originally
invest and that remains in the company. Shareholders are rewarded for their investment risk through
the increased value of the company (increase in share price) and through regular cash payments
made by the company (dividends). Thus the cost of equity is, in essence, the shareholder’s
minimum expected rate of return on their investment. The cost of equity is dependent on market
conditions and the investment risk associated with the company.
The total cost of capital then becomes the average of the cost of debt and the cost of equity, weighted
by the proportion of each – i.e. the Weighted Average Cost of Capital (WACC). This concept is
discussed below.

Risk and Return

All investment, whether it be a bet on a horse race, real estate, shares or government bonds come
with risk, but some investments are riskier than others. U.S. data compiled between 1926 and 2016
on returns of various stock and bond market indexes is presented in Figure 1 and demonstrates the
typical performance of different types of investments i.e.:
U.S. Treasury bills 3-month loans issued each week by the U.S. government are considered a
close to risk-free investment.
Long-term Treasury bonds issued by the U.S. government are also almost certain to be repaid
when they mature in about 20 years, but the prices of these bonds are geared to interest
rates.
The riskiest of the three are common stocks, or shares, because a shareholder’s return is net
of the bonds and any other debt the company holds, and there is no guarantee that the
invested money will be returned (Bealey, Myers and Marcus, 2001; New York Life
Investments, 2017).
The adequacy of a return on investment (i.e. the financial gain over a specified time period,
expressed as a percentage of the initial investment) depends not only on the size and timing of future
cash flows, but also on the risk (i.e. chance that these forecast cash flows will actually happen). Most
investors possess some level of risk aversion. All else being equal, they know that risky investments
are less desirable than safe ones – a safe dollar is worth more than a riskier one. Thus investors
demand a higher rate of return for risky investments. As a result, the performance of the investment
types presented in Figure Figure 2 is correlated with their inherent risk. Note also the difference in
volatility (i.e. the amount of variation in the returns over time) between the lowest risk (treasury bills)

1
Lender risk includes failure to repay the loan, the term of the loan and the ability for the lender to sell the
loan.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 238

and the highest risk investments (stock market) – this relative variability is an indirect, but critical,
input into Discounted Cash Flow (DCF) analysis and will be discussed later.
$100,000

Small St ocks
$33,212
Large Stocks
$10,000
Government bonds $6,035

Treasury bills
$1,000
Inflation

$134
$100

$21
$13
$10

$1

$0
1920 1940 1960 1980 2000 2020

Figure 1: Growth of US$1 in U.S. stocks, bonds, bills 1926–2016 (data from New York Life
Investments, 2017). Note the difference in volatility between the lowest risk (treasury bills)
and the highest risk investments (stock market).

Compound Interest and the Time Value of Money

Money deposited in a bank account will, of course, earn compound interest. So if a financially savvy
individual were offered the choice between receiving $100,000 now or $100,000 at the end of the
year, that person would take the money now to get a year’s worth of interest (see Figure 2 as an
example). This is the concept behind the most fundamental financial principal: a dollar today is
worth more than a dollar tomorrow. In fact, it is easy to work out how much the invested $100,000
will be worth in the future using the Future Value (FV) formula:

Where
PV = present value
FV = future value
i = interest rate
n = time in years
The Present Value (PV) of $127,628.15 is $100,000, which is the original investment – the value of
a dollar in five years’ time is only worth 78.35 cents right now.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 239

Figure 2: $100,000 invested for 5 years at a compound interest rate of 5 per cent. Simple formulae
(see text) allow the calculation of the future value (FV) of the investment. In 5 years’ time the
original investment is worth $127,628.15. The value of the future interest is less today due to the
time value of money. The present value of the investment (PV) is equal to the original investment.

This process of adjusting future values to present values is called discounting and is the opposite of
compounding. Discounting is used to determine the present value of a payment or cash flow that is
expected in the future. This is the fundamental concept behind NPV and other DCF techniques for
project evaluation. The key term in the PV formula is the discount factor, (1+i)-n or 1/(1+i)n where i is
the discount rate.

Discounted Cash Flow

Creating value for the investors or shareholders is the ultimate objective of a company’s
management and, by extension, all of its employees. In every activity a mining company undertakes,
whether it is a major new mining project, the addition of a new excavator to the mining fleet of an
existing one, value is created when expected returns > expected costs.
Investors in projects demand compensation for the future returns generated by their capital
investment, because a dollar today has more value than a dollar received in the future. This
compensation is geared to the relative riskiness of the future cash flows associated with the project.
For mining project evaluation when discounting projected operating cash flows, a discount rate must
be applied that reflects the minimum expected rate of return of all investors (i.e. the total cost of the
capital), based on the expected returns of similar opportunities (Lilford, Maybee and Packey, 2018).
In practice, most valuations use a rate or range of rates comprised of the underlying WACC adjusted
for the risk associated with the project’s geographical location (risk adjusted discount rate) – this is
why discount rates are often higher for projects in non-OECD (Organisation for Economic Co-
operation and Development) countries. To account for differences in risk between individual cash
flow streams, different discount rates may be applied.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 240

Net Present Value
For any project, the amount of money that the company invests is the cost of the project and the
resulting cash flows resulting from that investment are the returns. However, the cash flows
generated by the project will occur at some time in the future and as discussed above, the value of
the future cash flows is worth less today due to the time value of money. The process of discounting
allows the determination of the present value of a project’s future cash flows and therefore whether
the present cost of the project is more or less than the expected return.
Thus project value i.e. NPV = sum of the discounted cash flows generated by the project – sum of
the discounted cash flows consumed by the project.
Some of the key inputs into a DCF model and NPV calculation are presented in Figure 3. Whilst the
choice of the discount rate has a direct impact on the NPV result, it is only one of many assumptions
that carry uncertainty. Usually factors that affect revenue (e.g. commodity prices, grades and
exchange rates) have the most significant influence on the economics of a project than those
affecting capital and operating costs. Start-up capital investment is normally in the present or in the
near future and can be estimated with a higher degree of confidence (Guj and Garzon, 2012),
however there are no shortage of examples of capital cost overruns in the mining industry (Lwin and
Lazo, 2016). Operating costs are generally less risky due to their relatively low volatility and relative
ease of management (Guj and Garzon, 2012).

Figure 3: Some of the key assumptions/parameters influencing DCF and the NPV calculation
(modified from Crundwell, 2008, p. 275).

To demonstrate, the cash flow projections for a proposed new mine are presented in Table 1 and
presented graphically in Figure 5Figure . The sum of the cash in-flows from the project is $115
million. The total value that this mine will add to the company is equal to the sum of all the cash in-
flows and out-flows, which is $115 million - $100 million = $15 million. Based on this simple
undiscounted analysis, the project would create value because the returns exceed the cost of the
project. However the time value of money is not accounted for in this calculation, so does this project
really add value? In Table 2, each of the individual future cash flows is discounted to the present
using the PV formula.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 241

 Table 1: Example simplified cash flow projections (rounding applied) for a proposed new mine
(data adapted from Rudenno, 2009, pp. 337-358).

YEAR 1 2 3 4 5 6 7 8
Cu produced (Kt) 20.7 21.6 19.7 18.8 18.4 17.9
Cu Price (US'000$/t) $2,393 $2,441 $2,490 $2,539 $2,590 $2,642
Total Revenue AUD$M $71 $75 $70 $68 $68 $68
Less:
Total OPEX AUD$M -$41 -$43 -$42 -$43 -$44 -$45
EBITDA $30 $32 $28 $25 $24 $22
Less:
Total Depreciation -$11 -$11 -$12 -$12 -$12 -$12
Amortisation of Exploration -$15
EBIT $4 $21 $17 $14 $12 $10
Less:
Interest -$4.2 -$3.7 -$3.3 -$2.8 -$2.3 -$1.9
Losses carried forward -$0.7
Taxable Profit $17 $13 $11 $10 $8
Less:
Tax -$6.0 -$4.8 -$3.9 -$3.4 -$3.0
Profit After-Tax (PAT) $11 $8 $7 $6 $5
Add back:
Depreciation $11 $11 $12 $12 $12 $12
Amortisation of Exploration $15
Losses carried forward $0.7
Net after-tax operating cash flow $25 $23 $20 $19 $18 $18
CAPEX - fixed AUD$M -$40 -$60
CAPEX - sustaining AUD$M -$2 -$1 -$2 -$2 -$0.5 -$0.5
Net Free Cash Flow (NFCF) -$40 -$60 $23 $22 $18 $17 $18 $18
Cumulative NFCF -$40 -$100 -$77 -$55 -$36 -$19 -$2 $15
Present Values of NFCF -$35 -$47 $16 $13 $10 $8 $8 $6
Cumulative Present Value of NFCF -$35 -$82 -$66 -$53 -$43 -$35 -$27 -$21

The NPV of a project is the sum of all the projected free cash flows discounted to the present using
the time value of money as defined by the NPV formula:

Where:
NPV = net present value
CFt = future cash flow for period t
t = period (usually a year)
n = project life (years)
k = discount rate

Mining Geology 2019 / Perth, WA, 25-26 November 2019 242

 $30

$15
$10

Year
1 2 3 4 5 6 7 8
-$10

-$21

-$30

-$50

Discount ed Free Cash Flow

-$70

Cumulative Net Present Value

-$90
Cumulative Undiscounted Free Cash Flow

-$110

Figure 4: Undiscounted and discounted cumulative free cash flow projections ($M)
for the proposed new mine (data from Table 2).

For the proposed mine shown in Table 1 and Figure 5 the NPV is in fact, minus $21 million. This
investment does not generate value because the returns in the future are worth less than their
equivalent value today – to the extent that the costs actually exceed the returns. For revenue
generating projects, an NPV of zero implies that all capital has been repaid and investors have
received their minimum required rate of return. NPVs greater than zero imply that the investor may
expect value generation, whereas value is destroyed by negative NPV projects.
Most DCF models are constructed under assumed certainty using single-point, expected (mean)
estimates of input variables generating single-point, central estimate values for model outputs. Once
a base case model (and hence NPV) has been established, standard practice is to then assess:
the sensitivity of the project’s NPV to the various inputs (sensitivity analysis) which may drive
further investigation and possible recasting of the model and
the range of NPVs that the project generates under various optimistic and pessimistic
development and operational scenarios (Guj, 2013a, p. 128).
There are numerous advanced project evaluation techniques and approaches in use such as Modern
Asset Pricing (Guj and Garzon, 2012) and Real Options Valuation (Guj and Chandra, 2019;
Inthavongsa et al, 2016; Antikarov, 2003), all of which have their fundamental basis in DCF analysis.

The Discount Rate

So, if the projected cash flows over the life of the project are known, how is the discount factor or,
more specifically, the discount rate determine? Figure 5 presents a summary 'flow chart' of the
NPV calculation showing the key inputs and the derivation of the discount rate, discussed below.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 243

 Figure 5: Summary 'flow chart' of the NPV calculation showing the key inputs of the free
cash flow model and the Weighted Average Cost of Capital informing the discount rate.
See text for definition of variables.

Weighted Average Cost of Capital

Opportunity cost is the “cost” that is incurred when an investor places cash into a project, so that the
cash cannot be invested in other, possibly more lucrative, investments that carry the same level of
risk (Crundwell, 2008, p. 163). Essentially the cost of capital for a company equates to the investor’s
opportunity cost of all capital invested in the enterprise, which includes both debt and equity (Lilford,
Maybee and Packey, 2018). The total cost of capital is the average of the after-tax cost of debt and
the cost of equity, weighted by the per cent contribution of each to the capitalisation of the company.
This averaging of capital cost is known as the WACC and is calculated as follows:

Where:
E = the amount of equity
D = the amount of debt
RE = the cost of equity
RDBT = interest rate on the company’s debts before tax
T = is the tax rate
The cost of debt is the interest rate on the company’s debts adjusted by the company’s taxation rate.
The cost of equity is more complex and involves the application of the Capital Asset Pricing Model
(CAPM), which accounts for the general economic conditions reflected in the stock market (market
or systematic risk) and factors that are specific to the company (specific or diversifiable risk2).
Detailed discussion of the CAPM can be found in introductory corporate finance textbooks, such as
Guj (2013a), Guj and Trench (2013), Crundwell (2008) and Bealey, Myers and Marcus (2001).
DCF techniques are sensitive to the discount rate used, so it is important to understand the concepts
behind the calculation of the discount rate. Fundamentally, the discount rate used in the DCF
evaluation of these investments is equivalent to the required return on investment which reflects both
the time value of money and a compensation for risk. A positive NPV investment adds value after

2
Investors cannot avoid systematic risk, but can mitigate specific risk by diversifying their
portfolios. As the number of market securities in a portfolio is increased, the portfolio risk
decreases, eventually approaching the overall market risk.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 244

having recovered all capital investments with compound interest equal to the discount rate (Guj,
2013a)
Choosing a value for the discount rate is usually specified by the company’s central financial
authority and is done from the viewpoint of the entire organisation (Crundwell, 2008 , p. 12), reflecting
the underlying WACC, adjusted for geographical risk. In large companies, the capital budgeting
process is usually separated from the financing decision. This renders the investment decision-
making process simpler and more transparent. In these circumstances most projects are assumed
to be financed entirely using the company’s own resources (e.g. retained earnings) and the risk-
adjusted discount rate will incorporate the company’s debt finance. In other circumstances a single
project requiring both debt and equity finance will include the interest expenses in the DCF model
and thus the discount rate would be adjusted accordingly.
When assessing and comparing projects, NPV is the key measure, however there are three common
additional parameters that should be used in conjunction with NPV, to help to assess the financial
health of a project. These are:
Discounted payback period
Internal rate of return
Profitability or capital efficiency index

Discounted Payback Period

The discounted payback period is the time taken for the investor to ‘get their money back’. At this
point, the discounted cash in-flows from the project are equal to the cash out-flows. In other words,
the discounted payback period is the time at which the future value of the initial investment equals
the future value of the cumulative cash flows (i.e. NPV = 0) (Crundwell, 2008, pp. 181-182; Guj,
2013a, p. 132)

Internal Rate of Return

The internal rate of return (IRR) is the value of the discount rate at which the NPV value is zero (i.e.
the project is value neutral) (Guj, 2013a, p. 132; Crundwell, 2008, pp. 173-176). The IRR is a relative
measure and does not depend upon NPV. IRR cannot be calculated directly3 and is determined by
setting the NPV formula to zero and solving by iteration:

Where:
CFt = future cash flow for period t
t = period (usually a year)
n = project life (years)
IRR = internal rate of return
If the IRR is less than the required return on investment required by the company (the ‘hurdle rate’,
normally higher than WACC or risk-adjusted discount rate), the investment is rejected. The IRR is
used in conjunction with NPV to compare or rank projects. When using IRR, it is important to note
that:
the highest IRR does not necessarily mean the highest NPV.
projects with unconventional cash flows (i.e. more than one period of negative cash flow) will
produce multiple IRR values.
where cash flows are all positive an IRR does not exist

3
The Microsoft® Office ExcelTM function IRR() calculates IRR for conventional cash flows

Mining Geology 2019 / Perth, WA, 25-26 November 2019 245

Profitability or Capital Efficiency Index
The profitability (PI) or capital efficiency (KE) index is the ratio of the present value of the cash flows
generated to the present value of the cash flows consumed:

PI is a measure of the profitability per dollar invested. Equivalent to a benefit-cost ratio, PI is used in
conjunction with NPV to compare or rank projects. If the amount generated is less than the amount
invested, the PI is less than one, and the investment is rejected. If the amount generated is more
than the amount invested, the PI is greater than one, and the investment is recommended. PI is
useful in the capital budgeting process to ensure capital is allocated to the highest value per capital
spend project(s). Like IRR, the profitability index is a relative measure – this means that used in
isolation, it cannot distinguish between the sizes of projects.

FINANCIAL ANALYSIS - WHAT’S IN IT FOR MINING GEOLOGISTS?

Mining geologists are an essential cog in the wheel of a successful mining company, but they
compete with all other departments on-site for both capital and operating budgets to perform their
work and add value to the company. The annual budgeting cycle can be a very competitive process
where each department presents their plans, sets out their budget requests and defines their
deliverables.
Those departments that can justify their budget requests using financial analysis and modelling tools
have a clear advantage over those departments that can’t or don’t. Consider the following example;
The mining department submits a capital budget request for two new trucks to increase production.
If such a request presents the actual capital cost of the purchase, the annual operating cost to run
the trucks, and the additional revenue generated from the extra production capacity, then it will be
possible to estimate the NPV, IRR and PI associated with this investment option. Such a financial
analysis could present a compelling case for investment. The processing department will also be
able to prepare similar financial justifications to support requests for de-bottlenecking or for
expanded production capacity.
How can the mining geology department compete with these requests? By having a reasonable
grasp of the basic financial analysis tools described in this paper and working with the mine
accountants and business analysts, mining geologists can build a simple financial analysis to help
justify budget requests – it doesn’t need to be rocket science! Several examples are presented
below.

Near-Mine Drilling Budget for New Mineral Resources

The mining geology group is often responsible for near-mine exploration aimed at finding new
Mineral Resources to replace mining depletion or to facilitate expanded production – typically such
programs will deliver Inferred Mineral Resources in the first instance and may be capitalised in the
company accounts. If so, requests for funding new drilling will be competing with other requests for
capital, and you can guarantee the company’s capital budget will be constrained.
A simple way to help justify a drilling budget request is to add an estimate of the value generated by
a successful program. The steps to do this are:
(a) Estimate the total cost of the drilling program, including costs to prepare a new resource
estimate – assume AUD 2.5 million.
(b) Estimate three possibilities for how much Inferred Mineral Resources will be discovered
from the program i.e. a conservative, realistic and optimistic amount – assume 100,000 oz
of contained gold, 200,000 oz and 300,000 oz respectively.
(c) Calculate the average cost of discovery per oz contained gold. In this example it ranges
from AUD 25/oz (conservative) to AUD 12.50/oz (realistic) to AUD 8.33/oz (optimistic).
(d) Compile industry-specific statistics to compare the cost of generating new Inferred
Resources in-house by your proposed drilling program versus typical acquisition costs if

Mining Geology 2019 / Perth, WA, 25-26 November 2019 246

 your company had to purchase Inferred Resources from another company. You may need
some assistance with sourcing these statistics, but there is a lot of publicly available
information.
(e) Compile statistics from your own company to illustrate that this is a good investment. If your
company undertakes grassroots exploration, has other mines, or is actively assessing
merger and acquisition options, it should be possible to get information about the metrics
being used in the other areas to guide investment choices.
There is no certainty that Inferred Resources will be upgraded and converted to Ore Reserves. Even
if they are subsequently converted to Ore Reserves and mined, there will be additional costs
associated with this step. Therefore, it is unwise to estimate the in-ground value of the Inferred
Resources discovered and use this value to justify the investment because it has no relationship to
the profitability of mining this material. However, if you have access to the typical costs associated
with converting Inferred Mineral Resources to Ore Reserves at your mine, plus typical all-in costs of
production (e.g. per ounce of gold), then it is possible to provide some estimates of the potential
profitability of new Inferred Resources.

Infill Drilling Budget to Upgrade Inferred Resources to Measured/Indicated and

Convert to Reserves
The process for this example is broadly similar to the example above. The total costs associated
with proving up Measured/Indicated Resources and converting these to Ore Reserves can then be
used as a basis to estimate the cost of defining Ore Reserves. This can then be compared to
industry-specific costs for acquiring Ore Reserves and company-specific metrics.

Justification for Additional Staff

Many mining geologists struggle to prepare justifications for additional staff. Using the example of a
request for an additional grade control or production geologist, consider the following steps:
(a) Estimate the total recruitment cost associated with the initial employment of the staff, e.g.
agency fees, advertising, interviews, relocation, etc.
(b) Estimate the total annual operating cost of employing the geologist, including salary,
superannuation and on-costs – including costs associated with a fly-in fly-out roster if
applicable.
(c) Estimate the annual financial benefit to the company by having the additional staff. There
are many ways to consider this issue and some will require you to collaborate with your
mining, processing and accounting colleagues to generate reasonable estimates. For
example:
i. Direct improvement in the correct allocation of trucks dispatched as ore and waste.
Each truck of waste misdirected as ore can be valued at the average process cost
per tonne and each truck of ore misdirected as waste can be valued at the
contained value of recoverable metal minus the average process cost per tonne.
ii. Reduction in dilution of run-of-mine mill feed. It will be possible to estimate the
additional profit generated by an incremental increase in head grade delivered to
the mill using an assumption that the processing costs and recovery remain
unchanged. For example if you believe the extra geologist will improve the average
grade of ore delivered to the mill from say 1.5 g/t Au to 1.6 g/t Au, it is then possible
to calculate the additional revenue, which can be assumed to be all profit, generated
in a year.
iii. Improvement in head grade of ore, material characterisation and blending.
iv. Reduction in penalty elements contained in the product.
v. Reduction in production delays, e.g. to grade control drilling activities, drilling and
blasting activities, excavation/trucking delays, etc.
If the geologist is employed for a three-year period, it is possible to estimate the NPV directly
attributed to the extra geologist, as illustrated in Table 2. It will always be easier to estimate accurate

Mining Geology 2019 / Perth, WA, 25-26 November 2019 247

cost inputs to this process, however the benefits will be harder to quantify and require judgement
and collaboration with your colleagues to produce plausible and defensible estimates. This type of
analysis can be used to demonstrate that there is a strong business case for employing an extra
geologist.
Table 2: Example of an NPV calculation to justify the employment of an additional geologist

Pre-
employment Year 1 ($) Year 2 ($) Year 3 ($)
($)
Recruitment costs 100,000
Direct and indirect employment costs 500,000 500,000 500,000
Direct financial benefit 1,000,000 1,000,000 1,000,000
Profit/Loss (undiscounted) -100,000 500,000 500,000 500,000
Profit/Loss (discounted by 10 per
-100,000 455,000 415,000 375,000
cent)
NPV 1,145,000

AN IRON ORE CASE STUDY

NPV, as discussed above, is the main tool employed in the mining industry to value a deposit, and
is ultimately used by company boards of directors to approve the mine development and fixed plant
construction. Following the commissioning phase, the role of the mine geologist is to monetise the
value thought to be there. Mine geology and grade control has been defined by Dominy et al (2009)
as a process of maximising value and reducing risk, through the delivery of quality tonnes to the mill
via the accurate definition of ore and waste.
In this definition, Dominy et al (2009) link the technical aspects of the mine geologists to the value
they generate. Of course, the cyclical nature of the mining business almost always results in periods
of cost reduction. Drilling, sampling and assaying costs (including people and vehicle costs) are
simple to quantify - what is less obvious is the hidden cost associated with poor ore and waste
allocation.
As commodity prices fall, the mine geologist is under pressure to reduce costs. This case study,
explores how the mine geologist, can use simple cash valuation methods to demonstrate the value
of sampling in this scenario commonly observed across the industry. In this case study value is
quantified at current value. It can be used to form the basis of an NPV analysis if required.
The case study presented here is from a small section of one of the Pilbara Iron Ore mines. The
mine is a dry crush and screen mine only, meaning in this example, processes losses for material
above the mining cut-off do not have to be accounted for. The area in question represents just 2.5
per cent of the mine’s annual production rate. At Rio Tinto Iron Ore, current practice is to sample the
blast cones from 10 m bench drill holes. Holes are approximately 6.5 m x 6.5 m apart, a significant
tighter density then the resource model which at best may be 50 m x 50 m drill spacing. Using the
blast hole data, logging data and mapping, a production model is generated which incorporates head
grade and product predictions (lump and fine percentages and grades). From this geo-metallurgical
production model, the mine geologist will determine what is ore and waste.
In this case study, our aim is to define the value proposition of the geological data density. As such
an experiment, as schematically shown in Figure 6Figure , was established with the only variable
changing being the drill spacing used to make the ore/waste allocation decision. To do this, a truth
data set was established and compared to eight alternative sample grids, each representing a visible
cost saving.
The truth data set is the entire 6.5 m x 6.5 m drill grid sampled on the same day and assayed by the
same on-site laboratory using the same methods and Quality Assurance/Quality Control (QA/QC)
protocols. Each hole is sampled and the production model generated. As individual 6.5 m x 6.5 m
blocks are not mined, a geologist would normally group blocks to form the final ore waste decision
map. In this experiment instead of using a geologist to make the ore/waste decision, an automated
decision algorithm was used. In the case the DiggerTM tool (Isaaks, Treloar and Elenbaas, 2014) was

Mining Geology 2019 / Perth, WA, 25-26 November 2019 248

used. For this experiment the choice of automated tool is not important, what is important is that the
tool unbiased and fully repeatable.

Figure 6: Design of experiment to determine value as a function of drill spacing. Between Grid One
(the truth data set) and the eight alternative grids, the only variable is the actual data input grid.

Once the truth grid and model is establish, eight alternative grids are established by decimating the
grids (Figure 7). Each of these eight grids represents the potential cost saving option a mine geologist
is so often asked to explore. For each of the eight alternatives, a new production model was
estimated (Figure 8) using the same parameters. Whilst there could have been some optimisation
of the search strategies and the block size to account for a wider drill spacing, the same parameters
and block sizes were used to ensure the only variable was the drill spacing. The DiggerTM algorithm
was used, again, with the same parameters. By comparing the delta from the truth model to the
alternatives in terms of tonnages and grades, the change in value can be easily determined.

Figure 7: The case study test area. Left shows the drilling at the resource definition stage and the
subsequent model. The red colours are blocks above the defines cut-off. Right shows the 9
potential grade controls grids from which final ore waste allocation decisions will be made.
For this study, Grid One, sampling of all blast cones, is the truth data set.

Mining Geology 2019 / Perth, WA, 25-26 November 2019 249

Figure 8 shows the results of the different model. As the drill spacing gets wider, the apparent
variability of the ore decreases. A difference plot is also shown - here, the value of the block in say
Grid Two is subtracted from the value in Grid One. The absolute value is then presented as a
percentage change from the truth. Note that as cost savings increase, that is as the sample grid
increases, the intensity of the deviation from the truth increases.

Figure 8: The truth mining model and the 8 alternatives coloured by Fe. The Red represents
material above the cut-off. Right, mining model absolute difference clearly showing that the
differences between the truth increases both spatially and in intensity.

To understand the impact this has on value, the impact on the final ore-waste decision must be
assessed. To do this, an automated block selection algorithm is applied. Figure 9, shows the results
of the truth data set and the Grid Nine. It is clear that while many areas show no difference in
ore/waste decisions, there are areas that do.
So far the study shows, that the sample grid spacing will impact the ore / waste decision. To assess
this in iron ore, the tonnage of saleable product can be used. Using the lump-fine product mix would
add more sophistication to the value case, however, in this situation the raw product tonnes will
suffice and allow the problem to be simplified. Off course, metal units could be used in gold or base
metal mines, or thermal units for coal mines.

Figure 9: Automated block selection algorithm - truth data set versus Grid Nine.

Figure 10 shows the ore tonnage delta for the 8 alternative grids from the truth grid. In most cases,
less ore is allocated to waste. In the absence of the tighter truth data set, these represents a hidden
loss or ore going to the waste dumps. Note that the wider sample patterns have more misallocation
of ore to waste. Considering Figure 10, approximately 30 kt of ore over this shot is misallocated.
Given this area is 2.5 per cent of annual tonnage, simply multiplying by 40 would provide an annual
indicative hidden loss of 1.2 Mt over a year.

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Quantifying the hidden ore losses, a financial evaluation is now possible. In the experiment, the
maximum sample cost saving would be in the order of $A25k. When this experiment was done in
2016, data published in the Rio Tinto annual report would suggest a cash margin of some US$30.2/t
(or AUD$40.24/t). Simply multiplying this out would suggest that a $25k cost saving in sampling
would result in a direct economic loss of $A48M. Note that this excludes royalties and other taxes.
None the less, it is clear that the investment in close spaced data has significant economic leverage
in ensuring the accurate allocation of ore and waste.

Figure 10: Change in tonnes by sampling pattern.

CONCLUSION
The role of the mining geologist is critical in ensuring the expected financial outcome generated by
the extraction of a mining company’s key ‘asset’ - the orebody – is realised or exceeded. However,
mining geologists’ awareness of the fundamental financial concepts that drive the mining industry
are often limited.
Mining geologists and mine management often have different views of the same problem – the
former understands the technical benefits of a proposed solution, the latter often only wants to know
the impacts on free cash flow.
Thus mining geologists are encouraged to seek the help of their company’s accountants and/or
business analysts to incorporate simple economic analysis into their justifications for new capital
expenditure and annual operating budgets.
Presenting a simple financial model will ensure mine management is provided with sufficient
information to illustrate the requested investment has strong financial merit, resulting in a higher
probability of budget approval.

ACKNOWLEDGEMENTS
The permission granted by Rio Tinto to publish this paper is gratefully acknowledged.

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