Estimating Costs for Mining Prefeasibility Studies

Part 1 - Introduction to Cost Estimating Why Estimate?

You will cover the following points in Part 1: Introduction to Cost Estimating.

reasons for the need to estimate mining costs:

exploration decision-making, resource analysis and pit planning, development decisions, acquisition decisions, and financing

organizations and agencies that provide standards an overview of cost estimating methods and their application methods to estimate ore and waste production rates

Introduction (See Summary for main points) If you are an exploration geologist, a mining engineer, a metallurgist, a mine accountant, or a practitioner of any of a number of other mining-related specialties, at some time you will be asked to do a cost estimatewhether you feel qualified to do so or not. Mining, after all, is an economic endeavor, and, after safety, the cost of mining and its related processes is one of the most important considerations in that endeavor. All of us involved in the industry, whether it be in exploration, planning, production, legal, or financing, need to have a handle on the cost of mining and its significance to what we are trying to accomplish. This course will introduce you to the methodologies of cost estimating, and prepare you to complete a credible estimate whether or not you have any cost estimating experience. It will draw on your education, experience and background and show you how to apply that background to a cost estimate. It will show you that you already know most of what you need to know to complete an estimate. The course will simply help you focus your efforts in the right direction.

We will talk about several methods for completing an estimate. Some of these methods, although commonly used by inexperienced estimators, are not recommended for use today. We will talk about why. The emphasis of this course will be on itemized cost estimating, which takes some time and effort to accomplish, but we will look at ways to minimize that effort if desired, as well as ways to carry the method on to more detailed and involved estimates if necessary. Anyone completing an estimate by one of the shortcut methods should at least understand itemized cost estimating in order to appreciate the reduced credibility of the shortcut methods.

Why Estimate Costs? (See Summary for main points) The need to estimate mining costs crops up during many phases of mine exploration, development, operations, and related activities. Following are some of the more common applications. Exploration decision-making Mining cost considerations play a minimal role in the early stages of grass-roots exploration projects, where attention is focused on geologic phenomena rather than economics. Assuming some exploration success, a need eventually arises to examine the potential economic benefits of further exploration efforts. As the cost of the exploration work increases, and when sufficient data is accumulated to make reasonable speculations about the potential size and grade of the target, most companies will conduct prefeasibility-level estimates of potential costs and revenues for mining the deposit. The decision to expend further exploration dollars typically depends on a reasonable expectation that an ore body exists that can be mined at costs that are less than revenues. The process of conducting these early estimates can be a very valuable exercise. The process can be thought of as an exploration tool in itself in that it forces the explorationist to begin thinking of his target as an actual mass of rock that must be excavated and moved, rather than thinking of it strictly in geologic terms. Questions that must be answered before the first cost estimate and subsequent economic analyses can be completed will help identify problem areas that should be addressed during, rather than after, the exploration phase. These questions include: "what mining method will be required?" and "what mine recovery and dilution factors should be assigned?" These questions will lead to other questions such as: "do we need more drilling to better define the ore/waste intersection?" "do we need to construct detailed bench plans to address this issue?" and "is our vein too narrow to mine without excessive dilution?" Very early in the study we must assume an ore grade, a mine production rate, and projected life. Once we have examined these issues in light of projected costs, we will be able to judge whether we need to expand our exploration program to increase reserves, or whether we should focus on drilling higher grade areas to improve projected grades. The first cost study will force us to make some preliminary assumptions about the location of mill and waste sites. These assumptions will give us an idea of how significant haulage costs are to the project, and will help guide the environmental analysis and permitting process.

Resource analysis and pit planning Fundamental to all reserve/resource estimates is the concept of cut-off grade. Whether the estimate is done using simple empirical methods or advanced geostatistical methods, a determination must be made of what grade of material to include in the estimate, and what to reject. Much has been written about how to define and how to determine cut-off grade. Methods may vary depending upon the data available, what the results will be used for, and the estimators choice, but basically, cut-off grade is simply the grade of material that results in a gross value for the material that is equal to the cost of exploiting the material. Material with a grade that produces a higher value is included in the estimate as ore. Material with a grade that produces a lower value is rejected as waste. The two variables in this relationship are grade and cost. Grade is determined by any of a number of empirical or geostatistical methods. Cost is determined by one of the methods described in this course. All pit planning techniques for determination of pit limits and shapes, whether hand methods involving construction of cross sections or block modeling techniques such as floating cone or Lerchs-Grossman, require an initial economic evaluation of volumes derived from cross sectional areas or blocks. All of the techniques require the calculation of net value for volumes of a slice or blocks. Hustralid and Kuchta (2006) note that four basic steps are involved in determining pit limits using hand methods.

A slice is selected. The contained value is compared with the costs. If the net value is positive, the pit can be expanded. If negative, the pit contracts. The final pit position (pit limit) is where the net value of the slice is zero.

Net value is the amount of money remaining after production costs are deducted from revenues to be obtained from the block or slice. Production costs for blocks will vary depending upon position in the pit, especially depth, even without consideration of changes in stripping ratio. As the pit deepens, the in-pit haul road lengthens, thereby increasing haulage costs for each block of material moved. This cost variation should be considered in the pit planning process. Commonly, once a basic production cost is estimated, the increased cost due to depth is accounted for simply by adding a percentage amount to the basic cost for each deeper bench. This is a shortcut that could be improved upon, provided costs are estimated using itemized techniques described in this course. Haulage costs can be readily adjusted for increased haul distance once bench height and in-pit haul road gradient are determined or assumed. The Sherpa Cost Estimating Software for Surface Mines (see Software on CostMine.com) handles this adjustment quite easily. Development decisions

Cost and economic analyses are fundamental to the decision-making process for broad issues such as whether or not to develop or expand a mine, and to more specific issues such as what mining method to use or whether to access by shaft or ramp. Hence, the cost estimate may be based on exploration data and early assumptions or on well-verified operational data. Acquisition decisions Knowledge of mining costs, and an expectation of profit, while not the only considerations important to acquisition decision-making, are certainly fundamental to the process. One common acquisition decisionmaking tool relies on costs alone, especially for globally traded commodities such as base metals. Estimated production costs for the property in question are compared to production costs for other producers of the same commodity, in a ranking of high to low costs, that demonstrates the amount of the commodity that is produced worldwide at costs higher than, and lower than, that expected for the property in question. A position towards the low cost end of the ranking is desirable based on the theory that when commodity prices turn down, the higher cost mines will shut down first, removing commodity from the market and driving prices back up again, thereby shielding the lower cost mines from price swings that might otherwise cause them to shut down as well. Financing A cost estimate is required in virtually all cases before project financing can be obtained, whether it be debt or equity financing obtained from bankers, institutional investors, individual investors, stock funds, or internal corporate funds. The cost estimate is an integral and important aspect of an economic analysis prepared for the purpose of obtaining financing. Unfortunately, the cost estimate sometimes receives inadequate attention during the process of financial analysis. Indeed, many people operating in this arena, particularly those outside the mining industry, are unfamiliar with the nuances of cost estimating and fail to realize the impact that seemingly insignificant details can have on the ultimate viability of their investment. Hence, the analyses tend to focus on financial and risk aspects, while the technical details and reliability of the cost estimate are paid only minor attention. It is, of course, the responsibility of mining professionals to assure that the reliability of the cost estimate is adequate for the purpose intended. Others Mandated technical reports Canada, the U.S., Australia, Chile, Peru, South Africa and other countries with significant equity markets for mining stocks are now requiring the preparation and reporting of cost estimates in conjunction with technical reports to be made available to potential investors. The best known of these requirements is the Canadian National Instrument (NI) 43-101 report. Legal Cost estimates are commonly required for a variety of purposes where legal issues are involved, such as appraisals, where the cost estimate may be important in application of income or cost

appraisal methods; mining claim validity cases where rights are held on the basis of "discovery;" lawsuits involving royalty or takings issues; taxation, whereby taxes may be levied on property value determined by potential income analysis; and other purposes. Mineral leasing Both lessor and lessee need reliable estimates of costs for effective negotiations of lease terms. Equipment selection Life cycle costing is an estimating procedure specific to equipment selection decision -making. The procedure utilizes many of the principles described in this class. Appraisals A cost estimate is an important step in a mineral property appraisal using the income method of the cost method of appraisal. Contract negotiations The contractor and contractee both need a good handle on estimated costs for successful negotiations.