Phased-approach to mine development, a proven business model for risk reduction
The “phased-approach” to mine development is a proven business model for investors to “de-risk” stakeholder investments before committing significant capital to a mining project. Stakeholders include shareholders, investors, local communities, government institutions, company employees and management. The strategy is to explore and build a mine in phases for the least amount of time and upfront investment dollars with subsequent investment based on continued success. Success means responsible de-risking of the project and demonstrated economic viability which warrants further investment.
This is not a new approach, but one that needs to be resurrected as a reminder that spending excessive capital on high risk mining projects needs checks and balances, like any other industry, in order to convince investors to participate and protect their invested capital.
A recent review of specific articles from 1890 to 1920 concerning mine construction and production for a silver district in Mexico outlines a phased-approach case history. A company was seeking investment for mine and mill construction but was unable to secure sufficient funds to go into production. They decided on a “phased-approach”. This meant limited underground mining and hand sorting of high grade silver and gold ore with direct shipment to a smelter. Profits from this small production was reinvested into the mine with production growth over a number of years, which enabled construction of infrastructure, a mill and mine expansion. After several years of expansion, the company commenced issuing dividends to its shareholders which distributed the wealth to all stakeholders. The district went on to produce over 150 million ounces of silver and gold equivalent. Most of which would have not been possible without this phased-approach.
A recent case history for a successful phased-approach to development is the Santa Elena Mine in Sonora, Mexico under the direction of SilverCrest Mines Inc.. I was the Chief Operating Officer, President and Qualified Person for this company, and was largely responsible for the design and implementation of the mine development phases that de-risked the investments in the project. The chronology of events leading up to production at Santa Elena illustrates the systematic and responsible phased-approach that built this mine into a success story despite the financing challenges of a bear market. Important events included;
The Deal: 2005 – SilverCrest successfully negotiated and acquired the historical Santa Elena Mine. The success was based on building a relationship with the local owner of the mine and not overcommitting the company to large payments or royalties. Project was purchased for US$4 million over five years with part of the $4 million paid in company shares thereby preserving precious cash. No residual royalties reduced non-productive drains on cash flow.
Discovery: 2006 – Initial discovery of the first 15 million ounces silver equivalent in the deposit that was potentially open pittable. Discovery cost was less than 10 cents per silver equivalent ounce.
Feasibility: 2007 to 2008 – Expansion of the open-pittable resource and identification of potential underground resources provided the basis for engineering and economic studies, operations permitting, and surface access rights negotiation.
Permit: 2009 – Receipt of operations permit in approximately six months after application. Phased-approach business model and plan in place for next five years of construction and expansion.
Financing: 2009 to 2010 – Secured US$20 million for Phase 1 construction of an open pit heap leach operation at the bottom of the market. “Boots on the ground” assured, construction of Phase I on time and under budget. The operation was cash flow positive from the outset.
Operations: 2010 to 2013 – Phase I, successful and profitable open pit heap leach operation with strict cost controls established led to increasing free cash flow for further expansion.
Expansion and Transition: 2014 to 2015 – Positive cash flows and cash balances enabled the funding of Phase 2 and 3 for an US$100 million investment, mostly from operating profits. These phases included the successful expansion and transition of the mine from an open pit heap leach operation to an open pit and underground mining operation with a new milling facility. Expansion construction again was on time and on budget.
During the period from 2005 to 2015, this phased-approach model was successful for Santa Elena Mine. Under the management of SilverCrest Mines Inc., stakeholders experienced a significant increase in wealth while building trust in management, minimizing shareholder dilution and mitigating risk at every stage along the way. During this successful period, market capitalization of SilverCrest reached a high of $276 million in comparison to approximately $20 million in 2005, a more than 10 fold increase in value. Without the phased approach it is unlikely the ultimate project could have been financed at the time nor the operating risks reduced to produce rapid recovery of the initial investment.
In today’s mining environment, there are multiple and significant risks to be considered before investing in a project. Such risks start at the exploration stage and escalate to the point of committing to a significant financing and investment for mine construction. A responsible management team will track these risks from day one and keep them in check until a production decision is made. However, most of the project risk does not occur until significant market value is placed on the project and a production decision is made. At this point, risk significantly increases.
Major risks include; technical challenges, financing availability, legal & permitting issues, political and social risks, market recognition, and management performance. In my experience, the highest risk items on this list, in priority, are management performance, legal & permitting issues, and local social risks. By using a phased-approach to development, all three of these risks are reduced for the investor. Let’s review each of these priority risks and the phased-approach benefit.
Most say, that a good project will get financing for development in any market conditions. The corollary to that is that good management can be successful with a marginal project while poor management can ruin a good project. From project acquisition to mine closure, management can destroy a good “technical” project through one or all of the following (not all inclusive);
- Upfront inexperience in responsibly negotiating the terms of an acquisition; over commitment in time and cost to the company.
- Lack of ownership in company and project; you will protect and build wealth if you have an invested interest.
- Commitments to expensive financings; bad timing for equity raises with significant dilution, and very expensive financings for construction that can cripple a good project.
- Minimal knowledge of obtaining and maintaining proper Corporate Social Responsibility; management must get this right from the beginning at all levels from the mine site to the upper regulatory agencies and senior political departments or the risk may become too high to proceed or to produce economically.
- No “boots on the ground”; if executive management is not hands on and consistently present on the ground for on-site decision-making then project failure is increased. On time and on budget for any stage of a project is almost impossible without executive boots on the ground.
- Lack of cost controls and immediate decision-making; executive management must have intimate knowledge of budgets and controls for spending with priority focus on cost overruns or “red flags”.
- Mismatched technical expertise; you need to admit your strengths and weaknesses before building a mine. Rarely do explorationists become mine-builders. This can be a humbling experience.
By applying the phased-approach model, the investor has an opportunity to test management’s performance before further investment is made.
Legal & Permitting Issues
The best thing management can do for a successful “legal” project is to have a legal representative that understands the project jurisdiction, in-country corporate structure and requirements, strong surface rights knowledge and agreements, country mining law experience, familiar with tax laws, attention to detail for filings, and knowledge of political and social aspects in the project area. A competent lawyer will keep everyone focused on the issues and will prevent costly delays while issues are being resolved.
Of all the risks to a project, permitting or the timing of permitting can bring a good project to a halt. This discourages investors, frustrates stakeholders and makes everyone including management disinterested in investing time and money. Management should intimately understand the legal permitting process in the project’s jurisdiction and reasonable timing to achieve permits based on local case histories.
By following a phased-approach model, most legal conflicts will come forward during Phase 1 of production and can be addressed in preparation for Phase 2 investment. Permitting an initial smaller phased project is usually considered more favorable and responsible by environmental & permitting decision-makers.
“Get it right or get it wrong, there is no middle ground when it comes to impacting communities”. Obtaining a social license to explore, construct and produce should be on everyone’s priority list in order to assure success. In my experience, most errors are made when a company representative makes verbal statements and promises to local communities in order to expedite work programs and then not fulfilling them or, worse yet, there is a misinterpretation of the promises made. The only promise that needs to be made for obtaining and maintaining a social license is, “With success of this project, anything is possible within reason”. The local communities along with local champions must see management as being trustworthy, compassionate to the needs of the communities, being present and available with “boots on the ground in communities” and having a genuine interest in responsible distribution of wealth with success.
By using the phased-approach model, trust can be built as staged success is achieved without the over commitment of jobs, wealth, local impacts and promises to keep.
Along with risks, there are always opportunities in a project. Using a phased-approach model can assist or even accelerate these opportunities in today’s market.
Many of the “mega” deposits with proposed “mega” capital costs are not financeable in current market environments. These projects present such unmitigated risks that their failure means certain destruction of shareholders value. Often within these types of deposits there is a higher grade portion that can provide a phased-approach with lower capital costs that provide a de-risked entry to the ultimate mega project.
Development time for a phased-approach project can be significantly less than an “all upfront” project. The phased-approach project is much more flexible and resilient to rapid changes in market conditions, availability of financing, and metal prices.
In summary, the phased-approach business model is a wise choice to ensure decreased risk in time and investment dollars. With decreased risk, more investors are willing to participate. In this industry and market, we can use all the help we can get!
By N. Eric Fier, CPG, P.Eng