Sept/Oct 2012

Eye on Business

Today’s feasibility studies must take energy costs into account

By Mauro Chiesa

The past decade has brought three major economic shifts that impact mining companies looking to expand existing mines or develop greenfield projects: product-destination markets have expanded from Europe, North America and Japan to include emerging markets in Asia, Africa and South America, which have nine times the population; energy costs have increased from $17 per barrel of oil on September 9, 2001, to over $140/bbl and back down to $100/bbl in the economic downturn; and public sectors are running fiscal deficits while mining remains profitable, leading cost-sharing for capital-intensive projects to be re-evaluated by governments.

As mining companies prepare their feasibility studies (FS), they should not underestimate the potential impact of these trends. This requires a thorough review of traditional cost and cost-sensitivity practices. To provide a starting point, the following factors must be taken into account when preparing an FS.

Milling costs – Energy costs are a major part of the mill-­processing cost formula. Countries often support mining projects by offering energy prices below cost as an incentive to industrial development. However, cost-recovery policies implemented due to public-sector deficits, combined with the increasing cost of energy, may alter the economic sustainability of certain projects. An FS may require analysis using a market proxy to confirm project viability should market costs prevail. Renewable and co-generated energy options also warrant review. The national grid should also be assessed to see where the grid’s fuel bases and capacities stand, especially in fast-growing, emerging economies whose fuel-base may be soon obsolete or taxed by the growth.

Energy distribution – With projects assuming more remote or frontier locations, and countries running fiscal deficits, it is no longer viable to assume supporting infrastructure will come from the public sector. Even if it does, the private procurement option should still be assessed due to the timing advantage, as infrastructure availability must often precede the project’s construction. Private procurement will also re­duce the risk of inflation and the “wish list” required of the public sector, allowing the mining company to focus more on obtaining investors and permits. However, the cost of procuring private infrastructure must be weighed against the tighter capital markets.

Land transport – Whether by rail or by road, transporting the end-product to tidewater adds additional energy expenditure – especially from a frontier location. The host country’s policy towards the pricing of transport fuels should be carefully considered; many countries in difficulty are pressured to remove or reduce such subsidies. Again, a market proxy may be helpful in determining the project’s sustainability.

Ocean transport – The global shift in destination markets impacts Cargo-Insurance-Freight pricing and Freight on-Board Asian Port payment term costs. The greater distance and the demurrage/queuing at the destination port, and the price of fuel are new cost factors. These aspects are generally dismissed as a “working capital” (inclusive of works in progress) of 60 days to 90 days, by the traditional FS. This is no longer accurate.

Logistics – Rising fuel costs force bulk carriers to reconsider the Less-than-Cargo-Load term, to raise the threshold volume required for a stop and to add extra stops to reduce excess capacity risk. For mining companies, this means more tonnage in the supply-chain, more inventory waiting at exit-the-mill, in-transit while on rail or truck, and at tidewater, and longer ocean-transit periods to Asian destination ports. The traditional FS has tended to overlook the specific logistical needs of a project’s situation relative to its markets. This would be an expensive oversight on capital requirements at a time of scarce funding.

In summary, globalization’s demands and the rising cost of energy have combined to render efficient transport and supply chain management essential and especially vital at a time of conservative capital markets. Combined with a public sector that may be less willing to subsidize, the FS must now include more relevant cost-proxy tests and relevant supply chain reviews to reflect the economic sustainability of a project. Simplistic sensitivity assumptions of, say, +/- 10 per cent for cost variances and of three months of working capital are less applicable. A mining company looking for a complete and current FS must insist the consultancy group doing the study has supply chain and energy expertise.

Mauro hiiesaMauro Chiesa is now a semi-retired consultant and has over 33 years of experience in financing and advising extractive and infrastructure projects around the world, having worked with multinational banks, the World Bank Group and EDC. He has an MBA and a BA from UBC.

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