Technical Due Diligence for Mineral Resource Acquisitions - My article in the Mining India magazine
The resource crunch in India has led to a large number of Indian companies seeking to acquire assets in foreign countries with a few to secure raw material supplies to their downstream operations in India or for trading. The transactions have been reported in energy minerals such as thermal coal and uranium, and ferrous and non-ferrous minerals like iron ore, base metal ores for copper, lead and zinc and several others. The foreign acquisitions in mineral resources have unique characteristics due to the nature of mining industry, some of the important ones are as follows:
• High risk projects
• Capital intensive
• Price takers (which may have changed off late)
• Cyclical cash flows and profits
• Remote locations
• High environmental and social impacts
• Finite life and depleting assets
• Mine closure and land reclamation liabilities
• High regulatory and political risks
These are generally considered while the acquisition decisions are made but one key factor that forms the backbone of the mining business is the resource base, for which technical due diligence is a must. In the race to acquire assets, time constraints limit the extent of technical due diligence and hence, the risks of geotechnical surprises are higher.
Three Keys
The keys to successful technical due diligences are three fold:
1. Competent persons – those who have relevant experience, certified by an agency that holds them accountable for their work. In case of India, such standard setting and monitoring adherence to those standards by qualified and certified experts do not exist, which makes the assessment of technical consultants tough. The need however is to hire consultants that may have experience in the same or similar minerals, in similar geological and geographical settings such that their experience can be leveraged.
2. Credentials – of the team that takes technical due diligence work. Here the stress has to be on the members of team rather than the firm, since hands-on experiences are usually held by individuals and most such experiences may not be transferred even with advances in knowledge management tools. That said, a firm can bring holistic view with experience from a wider range of minerals, geographies and geologies, which may be bring in new perspectives and hence allow better technical assessment.
3. Work plan and time frame – these become critical when there are pressures to complete the assignment on time. The decision-makers need to assimilate the findings of technical, financial, legal and commercial due diligences within the time frames allowed by the sellers and come up with a firm offer, which usually creates a constraint on the accuracy and precision of assessments. Technical due diligence in mining may be considered the element that requires longer time due to large number of complex assessments done, ranging from adequacy of exploration, appropriateness of exploration methods, assessment of information capture and analysis techniques, assessment of assaying and chemical analysis, ore body modeling, resource and reserve assessment, geo-technical review and mine planning, equipment selection and several other key parameters. Time constraints typically hastens the processes of checking adequacies and appropriateness of processes and forces focus on the relevance of the outcome, which are in the forms of estimated resources and costs of mining to markets. This can leave exposure to risks and may have significant impact on investments subsequently.
Components of Technical Due Diligence Studies
The first level objective of the due diligence study is to arrive at resources and reserves available. Generally, resources are those quanta of mineral that have reasonable likelihood of profitable extraction, which are then classified into measured, indicated and inferred categories in the decreasing order of confidence. Reserves are economically mineable part of resources that are demonstrated through appropriate studies and are classified as proven and probable confidence categories.
For prudent assessment of reserves and resources, one of the concerns is the quality and quantity of data. South African, Australian and Canadian industries have set standards of processes for data collection, analyses and computations, which are summarized in compliant reports. Reliability of data points to reliability of the resource and reserves computations and these typically follow the rule of garbage-in-and-garbage-out. It is in the data that lays the reliability factor since the ore body modeling and computations are entirely based on input data, and hence, salting or peppering exploration data can lead to misleading reserves and resources assessments. The pertinent question therefore is if the data is verifiable. In cases of time frames being liberal, a few boreholes may be drilled at locations from where samples were picked for report preparations and results may be compared.
The processes of surveying, sampling, drilling, logging, coring, collection of samples, storage of samples, testing, chemical analyses and tabulation of results may be compared with standards established by JORC of Australia, for example, to test their appropriateness.
The data management system verification is another part of the technical due diligence. The best practices in this aspect require survey control, processes of data verifications, control of metadata (data in the raw format that is formatted subsequently), and process and frequency of updates. In some of the potential transactions for coal mining in Indonesia, the standards of data management systems were quoted as a concern.
Resource modeling has turned sophisticated with advent of computers and there are several software products available to help. The geo-statistical tools are built into the software although there are manual options as well to choose among the methods of data correlation and hence, modeling of ore bodies. Key inputs to development of these models are exploration data about thickness, quality parameters and surveys, so that the model turns into a three dimensional representation. As part of the due diligence process, one can verify data input and the competent person can verify the ore body model and run scenarios to establish impacts on the resource and reserve estimates.
Subsequent to ore body modeling, classifications of ore contained in the asset into various categories of reserves and resources are done in accordance with technical, legal and economic feasibility parameters, which are combined with probabilistic scenarios. Technical feasibilities depend on depth, dip and strike, number of folds and faults, hydro-geological features, topographical features and several others. Legal feasibility parameters are with regard to permissibility of mining in the proposed areas, which may be restricted due to forest type, population or such other factors. The economic parameters typically are costs of extraction and expected realizations of the mined products.
The economic parameters also depend upon the mine planning exercise that is done as an iteration to establish reserves and resources. Mine planning (different from the statutory requirement under the Indian laws) typically includes determination of mine design, equipment selection, excavation schedule, design of haulage, waste dump locations, defining locations for mine infrastructure and such other features. These indicate development and capital expenses. The annual costs of operations are also estimated based on excavation and production schedules, requirement of human resources, fuel consumption, consumables, environmental compliance requirements, social commitments, royalties and taxes, and such others.
Technical due diligence therefore requires assessment of these assumptions and their inter-relationship with resource and reserve estimation. These, however, may be easier from the process point of view as the software products can shorten the time required for review. However, the assessment of assumptions that are more commercial in nature may require multi-disciplinary team to conduct a thorough technical due diligence.
Risks of Failure in Technical Due Diligence are high
By nature the risks in mining projects are magnified at the start of the project. If the subject of due diligence is a green-field asset, the significance of technical due diligence is enormous. An error in diligence may result in over payments for acquisition for sure but continued reliance on the data made available during the transaction process may lead to incorrect mine design, which may have far greater impact on investment returns.
In one of the cases, reliance on the geological data and ore body model led to a company investing in shaft sinking on the hanging wall side, which had the risks of collapsing and hence, had to be abandoned subsequently. The investments in terms of both time and efforts yielded a failure which could have been prevented by a closure due diligence, at a cost that could be only a fraction of investment and opportunity cost lost.
Failure in technical due diligence may have one or several of the following risks:
a. Investment in unworthy asset
b. Technical issues in future development of mine
c. Selection of inappropriate fleet of equipment
d. Compromise on the production capacities
e. Loss of mineable reserves due to construction of infrastructure on the surface
f. Poorer design that lead to higher operating costs
g. Environmental issues
The list is not exhaustive and there can be several other results which may be due to hasty technical due diligence.
Technical due diligence therefore has high impact risks for which there must be care taken to ensure that the required checks have been done to establish credentials of the asset well. While in comparison the future costs may sure be higher but immediate costs tend to dry up financial resources of the investor and enhance the risk appetite to a level that forces the investor to forego prudent acquisition opportunities that come subsequently.
Conclusion
While there may be a trade-off necessitated by transaction time frame for acquisition of mineral resources, it may be wise to investigate the subject mineral asset prudently. These involve assessment of processes and outcomes to delineate and definition of resource bases. It may be prudent to hire consultants that have relevant experience for taking such due diligence work and a multi-disciplinary team may add perspectives to the process. The findings of technical due diligence should be appropriately discussed before the investment decisions are made. While the significance of legal, financial and commercial due diligence exercises cannot be undermined, technical due diligence does form the back bone since the reserves and resources are the prime value-drivers of mining projects. This also because mine design and construction done relying on the same technical inputs may lead to irreversible damages whose financial impacts may be huge.
• High risk projects
• Capital intensive
• Price takers (which may have changed off late)
• Cyclical cash flows and profits
• Remote locations
• High environmental and social impacts
• Finite life and depleting assets
• Mine closure and land reclamation liabilities
• High regulatory and political risks
These are generally considered while the acquisition decisions are made but one key factor that forms the backbone of the mining business is the resource base, for which technical due diligence is a must. In the race to acquire assets, time constraints limit the extent of technical due diligence and hence, the risks of geotechnical surprises are higher.
Three Keys
The keys to successful technical due diligences are three fold:
1. Competent persons – those who have relevant experience, certified by an agency that holds them accountable for their work. In case of India, such standard setting and monitoring adherence to those standards by qualified and certified experts do not exist, which makes the assessment of technical consultants tough. The need however is to hire consultants that may have experience in the same or similar minerals, in similar geological and geographical settings such that their experience can be leveraged.
2. Credentials – of the team that takes technical due diligence work. Here the stress has to be on the members of team rather than the firm, since hands-on experiences are usually held by individuals and most such experiences may not be transferred even with advances in knowledge management tools. That said, a firm can bring holistic view with experience from a wider range of minerals, geographies and geologies, which may be bring in new perspectives and hence allow better technical assessment.
3. Work plan and time frame – these become critical when there are pressures to complete the assignment on time. The decision-makers need to assimilate the findings of technical, financial, legal and commercial due diligences within the time frames allowed by the sellers and come up with a firm offer, which usually creates a constraint on the accuracy and precision of assessments. Technical due diligence in mining may be considered the element that requires longer time due to large number of complex assessments done, ranging from adequacy of exploration, appropriateness of exploration methods, assessment of information capture and analysis techniques, assessment of assaying and chemical analysis, ore body modeling, resource and reserve assessment, geo-technical review and mine planning, equipment selection and several other key parameters. Time constraints typically hastens the processes of checking adequacies and appropriateness of processes and forces focus on the relevance of the outcome, which are in the forms of estimated resources and costs of mining to markets. This can leave exposure to risks and may have significant impact on investments subsequently.
Components of Technical Due Diligence Studies
The first level objective of the due diligence study is to arrive at resources and reserves available. Generally, resources are those quanta of mineral that have reasonable likelihood of profitable extraction, which are then classified into measured, indicated and inferred categories in the decreasing order of confidence. Reserves are economically mineable part of resources that are demonstrated through appropriate studies and are classified as proven and probable confidence categories.
For prudent assessment of reserves and resources, one of the concerns is the quality and quantity of data. South African, Australian and Canadian industries have set standards of processes for data collection, analyses and computations, which are summarized in compliant reports. Reliability of data points to reliability of the resource and reserves computations and these typically follow the rule of garbage-in-and-garbage-out. It is in the data that lays the reliability factor since the ore body modeling and computations are entirely based on input data, and hence, salting or peppering exploration data can lead to misleading reserves and resources assessments. The pertinent question therefore is if the data is verifiable. In cases of time frames being liberal, a few boreholes may be drilled at locations from where samples were picked for report preparations and results may be compared.
The processes of surveying, sampling, drilling, logging, coring, collection of samples, storage of samples, testing, chemical analyses and tabulation of results may be compared with standards established by JORC of Australia, for example, to test their appropriateness.
The data management system verification is another part of the technical due diligence. The best practices in this aspect require survey control, processes of data verifications, control of metadata (data in the raw format that is formatted subsequently), and process and frequency of updates. In some of the potential transactions for coal mining in Indonesia, the standards of data management systems were quoted as a concern.
Resource modeling has turned sophisticated with advent of computers and there are several software products available to help. The geo-statistical tools are built into the software although there are manual options as well to choose among the methods of data correlation and hence, modeling of ore bodies. Key inputs to development of these models are exploration data about thickness, quality parameters and surveys, so that the model turns into a three dimensional representation. As part of the due diligence process, one can verify data input and the competent person can verify the ore body model and run scenarios to establish impacts on the resource and reserve estimates.
Subsequent to ore body modeling, classifications of ore contained in the asset into various categories of reserves and resources are done in accordance with technical, legal and economic feasibility parameters, which are combined with probabilistic scenarios. Technical feasibilities depend on depth, dip and strike, number of folds and faults, hydro-geological features, topographical features and several others. Legal feasibility parameters are with regard to permissibility of mining in the proposed areas, which may be restricted due to forest type, population or such other factors. The economic parameters typically are costs of extraction and expected realizations of the mined products.
The economic parameters also depend upon the mine planning exercise that is done as an iteration to establish reserves and resources. Mine planning (different from the statutory requirement under the Indian laws) typically includes determination of mine design, equipment selection, excavation schedule, design of haulage, waste dump locations, defining locations for mine infrastructure and such other features. These indicate development and capital expenses. The annual costs of operations are also estimated based on excavation and production schedules, requirement of human resources, fuel consumption, consumables, environmental compliance requirements, social commitments, royalties and taxes, and such others.
Technical due diligence therefore requires assessment of these assumptions and their inter-relationship with resource and reserve estimation. These, however, may be easier from the process point of view as the software products can shorten the time required for review. However, the assessment of assumptions that are more commercial in nature may require multi-disciplinary team to conduct a thorough technical due diligence.
Risks of Failure in Technical Due Diligence are high
By nature the risks in mining projects are magnified at the start of the project. If the subject of due diligence is a green-field asset, the significance of technical due diligence is enormous. An error in diligence may result in over payments for acquisition for sure but continued reliance on the data made available during the transaction process may lead to incorrect mine design, which may have far greater impact on investment returns.
In one of the cases, reliance on the geological data and ore body model led to a company investing in shaft sinking on the hanging wall side, which had the risks of collapsing and hence, had to be abandoned subsequently. The investments in terms of both time and efforts yielded a failure which could have been prevented by a closure due diligence, at a cost that could be only a fraction of investment and opportunity cost lost.
Failure in technical due diligence may have one or several of the following risks:
a. Investment in unworthy asset
b. Technical issues in future development of mine
c. Selection of inappropriate fleet of equipment
d. Compromise on the production capacities
e. Loss of mineable reserves due to construction of infrastructure on the surface
f. Poorer design that lead to higher operating costs
g. Environmental issues
The list is not exhaustive and there can be several other results which may be due to hasty technical due diligence.
Technical due diligence therefore has high impact risks for which there must be care taken to ensure that the required checks have been done to establish credentials of the asset well. While in comparison the future costs may sure be higher but immediate costs tend to dry up financial resources of the investor and enhance the risk appetite to a level that forces the investor to forego prudent acquisition opportunities that come subsequently.
Conclusion
While there may be a trade-off necessitated by transaction time frame for acquisition of mineral resources, it may be wise to investigate the subject mineral asset prudently. These involve assessment of processes and outcomes to delineate and definition of resource bases. It may be prudent to hire consultants that have relevant experience for taking such due diligence work and a multi-disciplinary team may add perspectives to the process. The findings of technical due diligence should be appropriately discussed before the investment decisions are made. While the significance of legal, financial and commercial due diligence exercises cannot be undermined, technical due diligence does form the back bone since the reserves and resources are the prime value-drivers of mining projects. This also because mine design and construction done relying on the same technical inputs may lead to irreversible damages whose financial impacts may be huge.
posted by Dipesh Dipu @ 9:53 PM
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