T his article fi rst appeared inEngineering and Mining Journal, September, 2005.
Taking it to the Bank – Making
your Mining Project Bankable
James Bre men and Adrian Lawrence
White & Case, London
In recent years the fi nancing of mining
projects has become considerably more
complex. In particular, the international
mining houses are more often seeking
to move project debt off their balance
sheets, and are using special purpose
companies with limited recourse fi nance,
in order to fund projects. The development
of the use of the “project fi nance” model
has brought a new level of sophistication
to the documentation and commercial
aspects of all these deals. There has been
a related though separate increase in the
number of mining projects going forward in
developing countries, particularly in Africa.
This is due to a greater understanding
of the risks in these countries, physical
advantages to mining various resources
in these countries and support to
these projects from a variety of lenders
including multi and bilateral development
institutions and export credit agencies.
Many developing countries are now
welcoming private investors into the
mining sector recognising that their
expertise and capital is needed to develop
these resources, and also recognising that
this is mutually benefi cial.
The structuring of a project fi nancing for
a mining project is a complex process.
The manner in which the fi nancing is
structured will have an impact upon
all parties involved in the project and,
as such, it is useful for all parties, both
principals and contractors, to have a broad
understanding of the sorts of issues
which will drive the way in which the
11. 05 | 012 61
James Bremen
Associate
deal is put together. The purpose of this
article is to outline some of the key issues
facing sponsors when endeavouring to
get a project “of f the ground” and, in
particular, identif y the key issues and risks
that the fi nanciers will want addressed
before any project gets funding.
Adrian Lawrence
Lenders in mining projects will consider Associate
the interrelation between the risks
inherent in a p articular mining project
and the (potential) rewards of a particular
project. The risks involved in a mining
project typically reduce as development
of the project moves forward. Each
stage in a mining project involves risks
disappearing and thus the risk/reward
balance tends to favour investment the
further forward a project goes.
The St ages in a Mining Project
After extensive exploration a mining
company may be able to identif y a major
new discovery. In order to develop the
project, the sponsors will need to move
through a number of key stages during
which they will need to address a number
of different risks in order to proceed to
the next stage. These risks include those
relating to:
1. Permits and
Approvals
There are a number of approvals and
permits that may be required depending
on the country. Common examples in
1
Taking it to the Bank – Making your Mining Project Bankable
developing countries include negotiating native
title agreements with indigenous claimant groups
and negotiating mining leases. The permits
and approvals required are of course extremely
country specifi c and present p articular problems
in many countries that are resource rich, such
as sub-Saharan Africa which will be brie y
considered below. Many analogous concerns
will exist for much of the former Soviet Union,
SE Asia and South America.
When considering what permits and approvals
are required there can be diffi culties involved in
the legal systems of Africa which may be not
developed enough to deal with the sophisticated
legal issues that arise in a project fi nancing.
Typical legal system related issues involve the
taking of security (fi xed and/or oating), unclear
and cumbersome fi ling requirements in relation
to security and other aspects of the project,
inadequate local counsel expertise availability
and practical dif fi culties in using the legal system
and the remedies it of fers if things go wrong.
In many African states the natural resources
are a major part of the country’s economy and
as such the government involves itself in every
par t of a mining project. The natural resources
will often belong to the central government and
the mining company may not be able to get
any kind of ownership rights either surface or
sub -surface. As the central government may
take 20% of the project revenues and individually
negotiate a tax package on a project by project
basis for other aspects of the project it is very
diffi cult in developing markets to evaluate and
offer a feasibility study without completing
this part of the develo pment process fi rst, at
least on an “in principle” basis. In practice
large projects will be of such importance to
many developing countries that they will tend
to try not to make a potentially feasible project
unfeasible through their demands – therefore
this stage will often, in practice, interact with
the feasibilit y repor t stage below.
Despite the various risks that make many African
mining projects more diffi cult than many other
countries, the lower costs of extraction mean
that the overall risk/reward balance of ten
remains favourable to these projects satisfying
lender requirements.
2. Economic Viability
Naturally just because a major discovery has
occurred does not mean that the project will
prove to be economically feasible. There must
occur after the major discovery a feasibility study
that will provide compelling reasons why this
particular discover y deserves exploitation. The
potential project will be evaluated from the early
stages of a mining project and these interim
evaluations will form the justifi cation of continuing
to put money into the potential project. There
will come a stage, often when at least outline or
“in principle” approvals and permits have proven
to be available that a formal feasibility study is
prepared. This feasibility study will explain why
this par ticular project is wor thy of investment, and
is often used to approach potential lenders with.
Project evaluation normally accompanies all the
earlier stages of a mining project and provides the
basis and justifi cation for continued investment
of money for the proposed development. The
evaluation process culminates formally in a fi nal
feasibility study, which will demonstrate the
economic feasibility of the project with the degree
of certainty required to make the investment
decision to bring the mine into production.
Certain kinds of discoveries are more likely to be
viable than others and this is re ected in how the
stock market values the shares of exploration
company’s post-discovery but pre-feasibilit y study.
For example, a gold discovery is, on average,
judged to more likely be economically viable than
a coal discovery. This is related to a number of
factors, such as the increased likelihood that the
costs of extraction will be outweighed by the
market price of gold but is also due to the fact it
is easier to sell gold production than it is to enter
into long-term off-take contracts for coal (these
of f-take contracts being essential for the project
fi nancing mo del, as explained b elow).
2
Taking it to the Bank – Making your Mining Project Bankable
3. Marke ting and
Sales
In project fi nancings the loan amounts involved
usually exceed the value of the project assets. As
such, since the lenders are principally looking to
the cash ow of the mining activities, the lenders
need to be reassured that the mined resources
can be sold – thus making their security package
adequate. The project company reassures the
lenders by entering into off-take contracts, which
are agreements that provide for the purchase of
all or a substantial par t of the resource that the
project will mine. This satisfi es the risk aversion
of both the lenders and the buyers of resources
since the lenders do not want the value of their
security package to rely on the (uncertain) future
resource prices and the buyers of resources
would prefer to know that they will be able to
buy the resources needed for their businesses
in years to come at a certain price so that they
can plan their strategy.
4. Construction and
Operation
The entering into of contracts for the construction
of the mining project and contracting for the
operation of the mining and other major contracts
with tenderers selected on a basket of qualities
such as price, quality, past performance and
reliability ameliorates signifi cant risks in the project
in that it provides (provided that the contracts
are suffi cientl y certain) actual fi gures to put into
the feasibilit y evaluation model.
Construction cost risk is that construction will run
over budget and thus reduce or even eliminate the
economic justifi cation of the project. If fi xed cost
construction contracts (broadly speaking, though
almost all construction contracts will include
the possibility of varied costs for unforeseeable
geological conditions etc.) are obtained by a project
company the lenders see this risk disappear, as it
is taken by a third party.
This has led to some sophisticated forms
of contracting being used. Increased lender
involvement in their negotiation has led to
contractors being forced to accept more risks
than they would previously accept. Contractors,
in particular, need to be well advised when
negotiating these agreements as they have a
veritable army of lawyers (sponsors and lenders)
drafting the proposed agreements (which are
often very sophisticated models) which are often
unfamiliar to traditional mining contractors.
Contractors may also be aske d to enter into a
“tripartite” or “direct” agreement with the lenders
which could potentially further limit their rights.
Operating risk is something that lenders have
also been willing to take within reason. Operating a
mining operation of course carries less uncertainty
and therefore risk than building it, so the focus
of the lenders will be on the construction risks
to a larger extent than the operating risks that
comes afterwards. Common parts of operating
risk are new technology risk, management and
labour issues, environmental and governmental
interference issues.
What makes a Project Att ractive to Lenders
Ultimately, the lenders will have to balance a whole
basket of different factors when considering if they
wish to lend to a particular project. There will of
course be the risk/reward trade -off on the particular
project but also factors such as reputational issues,
exposure to other similar projects either by industr y
or geographically and so on.
In a more general sense we can say that lenders
lo ok for a project that has a good anticipated cash
margin (compared to other current or prospective
mining operations) due to unique or unusual
physical characteristics of that p articular project. It is
preferable for the project to make economic sense
due to geological ( e.g . producing an unusually high
quality product; low strip ratios) or geographical
(e.g. short transportation distances; good infrastructure)
considerations rather than an exceptionally good
or innovative management or similar (potentially
transient) advantages. Indeed having a realistic
development plan and a management with a solid
track record and a proven dedication to success
are prerequisites rather than advantages of mining
projects, given the risks the lenders already face.
Conclusion
Mining projects in the developing world have a
unique set of risks. Lenders have now become
3
Taking it to the Bank – Making your Mining Project Bankable
more comfortable with this environment and are
more willing to advance funding for mining projects
in these parts of the world. The growth of the
project fi nance model in the mining sector has
brought a further degree of complexit y to the sector
and this, coupled with increasing exposure to the
developing world has meant that the positions that
par ties (be they sponsors, lenders or contractors)
are taking are becoming increasingly harder.
Well – advised companies are taking full advantage of
the differing models of funding currently available.
While in the past lenders were more conservative
in lending to mining projects in diffi cult jurisdictions,
such as sub -Saharan Africa, they are increasingly
becoming more willing to shoulder these risks as the
lower extraction costs and other natural advantages
make these regions attractive when the risks and the
rewards are weighed.
The information in this article is for educational
purposes only; it should not be construed as
legal advice.
Copyright © 2006 White & Case