How Mining Companies Improve Share Price by Destroying Shareholder Value - OR - How the Junior Geologist and Engineer Determine the CEO’s Bonus

CIM Montreal 2003
Abstract For some years, the mining industry has been consistently delivering returns below the market average. During that time, the author has become aware of a disconnect between what is perceived to drive value creation by many industry analysts and senior corporate executives, and what drives the intrinsic value of mining operations. The perverse effect is that strategies that should increase value drive share prices down, and vice versa.

This paper challenges common perceptions of what drives a mining company’s value. Examples indicate that the key drivers of value in the market, and hence in many board rooms, are such things as increasing the reserves and production rate, and reducing unit operating cost. However, while the quoted reserves may satisfy ore reserves reporting code requirements to be economic, this does not imply that they are optimal. Often, a proportion of the quoted reserve reduces the potential value of the operation. Targeting a higher “round number” production rate is seen as good, but the capital cost to achieve this may be excessive. Operating cost reduction may be good, but not if it has been bought by excessive capital expenditure. Also, value may not increase since gains from lowering costs tend to pass to customers as lower prices.

Results from case studies indicate that value is maximised by right-sizing, not maximising, the production capacities, and by optimising the cutoff strategy. Values of many underground mining operations can be increased significantly by a substantial cutoff grade increase. Also, an increase in downside risk, and hence reduced returns, can occur using typical life-of-mine planning strategies if prices received are lower than predicted. Since this is often the case, low industry returns may be a direct result of typical strategic mine planning processes.

Relatively simple cost-effective techniques are available to provide senior decision makers with information needed to assess the tradeoffs between their many conflicting corporate goals, and the balance between risk and reward. Often this information is not being generated at all. If it is, decisions affecting the value of the company are occurring by default at relatively low levels within the hierarchy, with senior executives apparently unaware of them or their potential impact. The paper concludes that without a re-evaluation of the way mining projects are valued, to demand proven value optimisation from mining plans by boards and mining analysts, the industry will continue to deliver below average returns.
Keywords: Mine valuation, mining strategy optimisation, Ore reserves, Risk management, cutoff grade
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