February 2015

Finance

Understanding project capital cost escalation of the 21st century

By Ken Thomas, John Wells and Maria Leticia Conca

Commodity_price_index
 
Commodity price index from 1960 to the present

During the second half of the 20th century, capital costs of mining projects were relatively stable, increasing about three to five per cent per annum, basically following the consumer price index. However, from 2002 to 2013, the industry saw project capital cost increases at an average of about 20 per cent per year. Similar project capital cost increases were reported widely across the globe, and in several cases more than doubled or even tripled during that time. Capital costs at Barrick’s Pascua Lama gold project in Chile increased to more than $8 billion in 2013 from $3 billion in 2009. In the same period, costs at Anglo American’s Minas Rio iron ore project in Brazil rose to $8 billion from $2.7 billion. This led to a general nervousness for investors thinking about financing projects from 2013-on. But is that nervousness justified, or can the price escalation be rationalized?

Commodity price increases were a prime contributor to escalation, along with rising costs of equipment, engineering, construction, labour, community relations and environmental impact assessments (EIAs). To understand how dramatic the commodity price increases have been, consider an index comprising a basket of commodities including copper, aluminum, nickel, zinc, gold, Brent crude oil and iron ore set at 100 in 2002.The index rose to 400 by 2013: a 300 per cent gain. The price of copper alone rose from around 75 cents per pound in the early 2000s to more than $3 per pound in 2013. For perhaps the first time, the price of almost all commodities – precious and base – jumped, driven by the huge growth of new industrial powers, namely Brazil, Russia, India, and, most notably, China. As the price of metals and commodities rose, the mining industry saw great opportunities to develop projects. Many deposits were well known but had been held back for a number of years by low commodity prices. Countless new projects received approval to proceed within a short period, and what had been a buyer’s market suddenly became a seller’s market for suppliers to the mining industry. This was compounded by a desire to shorten delivery times and the increased cost of the metals used to manufacture the equipment. The quoted prices for equipment increased dramatically, doubling or even tripling, particularly for the large items such as grinding mills and haul trucks.

Engineering costs rose in parallel with equipment costs from 2002 to 2013. This was a big change from previous decades when engineering companies frequent­­ly engaged in fierce pricing competition to stay in business. In several cases the salaries of all levels of engineering staff grew by at least 100 per cent. In addition, project execution became far more risk averse, and it is now common practice in mining jurisdictions to require a step-by-step approach through several levels of study: scoping, prefeasibility and feasibility. Furthermore, these studies must now incorporate more information such as detailed chapters on community relations, EIAs and health and safety considerations. To further compound and complicate matters, technical studies need to be carried out in close liaison with the EIA, which is usually executed by a separate company. All of this adds to upfront capital costs and requires more time.

Construction companies also found their resources too little to work on the many projects as demand outpaced supply. Generally, construction contractors are asked to supply concrete, structural steel, piping and electrical cable. The escalating cost of commodities accordingly caused construction costs to increase.

Labour became an issue when the mining industry was faced with many new projects and several cost-related impacts occurred. The engineering and construction companies, as well as the mining companies, promoted employees who, in many cases, did not have enough project, technical or managerial expertise. Furthermore, salaries and benefits rose rapidly, reflected by signing bonuses added to contracts to attract personnel. At the same time, to try to control labour costs, people were moved into mining projects from other industries, creating an inexperienced workforce. This resulted in project schedule overruns and re-work costs from shoddy workmanship.

The increase in almost all commodity prices led to an unprecedented boom in exploration, studies, projects and takeovers. Operating companies, reacting to the high prices, raced to get new projects off the drawing board and into production. This created an imbalance in the supply and demand for equipment, engineering, labour and associated services that set off cost escalation. Many companies are now evaluating all of their projects frequently to prioritize and ensure only those with acceptable risk and suitable economics, as evaluated by their net present value and internal rate of return, go forward. At the same time, exploration budgets and operating efficiency are being examined to conserve cash. Fortunately, commodity prices and accordingly capital costs appear to have levelled off since 2013, which will hopefully stabilize the mining industry in the coming years.

Ken_Thomas
Ken Thomas is president of project development and metallurgy at Ken Thomas & Associates Inc. and is board director with Continental Gold, Candente Gold and Avalon Rare Metals. He has served as senior VP of projects at Kinross Gold Corporation, global managing director and board director at Hatch, COO at Crystallex International Corporation, and senior VP of technical services at Barrick Gold Corporation.
John_Adrian_Wells

John Wells is an independent consulting metallurgist, based in Vernon, B.C., and Santiago, Chile, as well as an associate metallurgical consultant to Alquimia Engineers of Santiago. He held increasingly senior positions with operating companies around the world, including director of metallurgical development with Barrick Gold. 

Leticia_Conca

Maria Leticia Conca has more than 38 years of professional experience in mining project development. She has been a CEO, operations manager and board member and has served as specialist engineer, chief of discipline, head of projects and as a consultant. She currently works as a professor and chair of metallurgical plants projects at the Universidad de Chile’s department of mining engineering.


Next: CSR
Ensuring social investments in mining creates value for local citizens and companies

Go to Feature: Grassroots Exploration

Go to Project Profile: Mary River


 

Go to Travel: Valledupar
Go to Table of Contents
 
           
Post a comment

Comments

PDF Version