Project cost overruns: Implications for public disclosure.

Mine trucksThere is a long history of cost overruns in mining. By some estimates, average cost overruns for mining projects range from 20 to 60%. This is, particularly, interesting when you think of the fact that most of our rules governing public disclosure require that capital cost estimates in pre-feasibility and feasibility studies should be ±25% and ± 15%, respectively. This is an issue that many have discussed at mining conferences. Notable discussions include presentations by Christopher Haubrich at CIM and PDAC and Runge Pincock Minarco’s newsletter article on this issue. I recommend you review these discussions for some background, if you are not already familiar with them.

My goal in this post, is to discuss the implications of cost overruns in the area of public disclosure. First, I will try to establish the connection between cost overruns and a company’s disclosure to the market. Then I will try to explain what the possible implications are of poor disclosure surrounding cost overruns to a mining company that is publicly traded.

In most jurisdictions, a company that is deemed to have material mining operations is required to provide disclosure that provides the market (investors) information with which it can assess the value of the company’s mining properties. As part of such disclosure requirements, a company is usually required to disclose material results of a pre-feasibility or feasibility study to justify disclosure of mineral reserves (i.e. the pre-feasibility or feasibility study is used to demonstrate economic viability of the mineral reserves). Often, because management is motivated to disclose reserves as soon as possible, pre-feasibility studies are used (except in the case of US companies who can only disclose mineral reserves based on final/bankable feasibility studies under Industry Guide 7) to support disclosure of mineral resources. Because pre-feasibility studies are less comprehensive than final feasibility studies, the results are inherently less certain. For example, the capital cost estimates are only required to be ±25% compared to ±15% for a feasibility study.

The cost estimates disclosed in these studies are taken by the market to be the best estimates of project capital costs. And, in fact, if the studies are properly done, these costs should represent the best estimates at the time of the study. As discussed elsewhere (see links above), there are many reasons why the actual capital costs will exceed the estimate in even a good pre-feasibility or feasibility study leading to cost overruns. But it is not always the case that cost overruns are due to poor engineering work during the feasibility study. In fact, there are many times where cost overruns are due to changes in scope that are necessitated by issues or conditions that most engineers would not have anticipated at the time of the feasibility study. The issue is what you do when these new conditions arise.

If conditions arise, that materially change the conditions under which the feasibility study was done and which  necessitate a new estimate (e.g. change in scope), the capital cost will necessarily be different from the estimate in the feasibility study. This is the case whether these conditions should have been anticipated by the qualified (competent) person(s) who wrote the feasibility study or not. And it is the duty of management to obtain new estimates for the project as soon as it becomes aware of the new conditions. This is just good project management.

Now then, what is the implication for the company’s disclosure? First, management has an obligation to correct the public estimate of capital costs. Most jurisdictions require that the study that supports disclosure of mineral reserves should be current (i.e. all material assumptions are current), in all material respects. Hence, to the extent that the capital cost estimate is a material assumption, a change in capital cost estimate should trigger a new disclosure. We do this all the time with commodity prices. This is no different. This is particularly important if the property in question is material to the financial or business condition of the company.

If management fails to disclose the revised estimate, regardless of the reason, the company risks being liable for providing materially misleading information about the profitability of the project. It is also important for qualified persons who provide consent to use their studies for disclosure to be mindful of these implications when they are aware of conditions that alter the capital cost estimate.

Obviously, there are many nuances to these issues. If you find yourself in this situation, I recommend you talk to your corporate counsel or an attorney who is familiar with disclosure issues. Since these issues tend to be very technical, engaging the services of an experienced qualified person or consultant who understands disclosure issues can be helpful too. Sphinx Mining Systems will be glad to help you navigate such issues, if you need help. Remember, the money spent to get this right is well worth it. Otherwise, you expose yourself needlessly to lawsuits.