Bull/Bear Markets and Mine Plans

This week, I read several articles on gold’s bear run on the markets (you can find my favorite here). Several news outlets noted that gold dipped below $1,500/oz., which takes it below 20% of its peak price (the official definition of a bear market). This made me wonder how this trend, if it were to continue (not that I think it will), affects the current mine plans at gold mines. If the trend continues, those of you in long-range mine planning are going to be getting calls from your boss (or the corporate office) asking for revisions to the current plan using different gold prices. In this post, I intend to share my thoughts on how mine engineers account for market volatility in long-range mine plans.

This article was first published on the blog in April 2013

Any mining engineer knows that long-range mine plans are sensitive to market conditions. Market volatility of the mine product is a major source of uncertainty in mine planning and mine evaluation for investment decisions. Consequently, bear market runs, like the one gold finds itself in, have implications for a mine’s existing plan. During mine planning there are 3 main ways mining engineers deal with such volatility:

  1. Use of long-term commodity price projection: Mine plans require a commodity price to establish cut-off grades, the extent of the mine, etc. In recognition of price volatility, the common practice is to make a projection (often a conservative one) of long-term commodity price(s).
  2. Analysis of reserve sensitivity to price: We often subject our reserve estimates to sensitivity analysis to determine how the reserves change with price. This leads to the common reserve-price curve, which is part of most feasibility studies. This is a strategy to understand how the mine’s value will change as price changes. As a mitigation measure, however, it is not robust because we don’t generate mine designs and plans for the alternate scenarios (i.e. scenarios of lower/higher commodity prices).
  3. Mine sequencing: Usually, our mine sequences start from the highest value nested pit (in open pit mines) or the lowest stripping ratio region (in strip mines). Intuitively, these sequences protect us against price volatility because we start the mine in the least “risky” area (i.e. the highest value nested pit is the least likely to result in a loosing operation when prices fall).

These strategies deal with the mine design and planning process. But, mine planning should be viewed as a process to generate alternate investments in order to find the best investment decision. This is done, in most cases, using discounted cashflow analysis with criteria like NPV and IRR. Even when discounted cashflow analysis is coupled with Monte Carlo simulation, it is limited in its ability to handle risk. Other more advanced techniques (capital asset pricing models and real options evaluation) have and can be used. Additionally, a mine or mining company can use market based risk-mitigation measures to insure itself against price volatility. Hedging is one such approach (most gold mining companies have completely eliminated their hedge books).

I do not think this week’s gold performance alone is cause for concern. As I pointed out earlier, over the last 5 years gold is still up (even more so over the last 10 years). So there is no need to panic yet. Hopefully, you are not going to get that call from your boss asking for a review of the mine plan. But I hope the next time you initiate a long-range mine plan, you will think about whether your plan is robust enough to withstand anticipated volatility.

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