Mine school

for expert investors

Dr Victor Rudenno
Summer 2006

Introduction
Mining 101 - An overview
Conducted by Dr Victor Rudenno, the guest author of our May 2006 CLSA U Blue Book Mine School Mining basics and equity valuation, this is an essential course for investors in the resources sector who wish to understand the basics of mining. The programme provides details and simple examples of the processes involved from exploration and mining, to processing and marketing a mineral resource, as well as the basics of commodity-price forecasting and equity valuation. Underinvestment in mineral exploration and strong demand growth from developing economies has driven commodity prices to all-time highs in some cases. In the past three years, the global mining sector has grown from a market capitalisation of about US$180bn to more than US$500bn, according to some estimates. An understanding of all of the critical steps required to find a mineral commodity and ultimately produce a saleable product, is critical for investors to successfully value resource equities.

Course instructor
Victor Rudenno holds a Bachelor of Mining Engineering, a Master of Commerce and was awarded a PhD for his thesis on Mining Economics. During his academic career he lectured at the University of New South Wales and the University of Sydney on mining economics, geostatistics, operations research and minerals processing. Published in numerous academic journals, Dr Rudenno is author of The Mining Valuation Handbook (2004). He is Principal Lecturer and Fellow of the Financial Services Institute of Australasia and a Member of the Australasian Institute of Mining and Metallurgy. Dr Rudenno entered the investment banking and stockbroking industry in 1984. He was a Director of Research at CIBC World Markets; a Director of the Investment Banking Division of Hartley Poynton Limited; Head of Resources, Corporate Finance at Deutsche Bank and an Associate Director at McIntosh Corporate. He was Chief Operating Officer and co-founder of ECM Limited, a corporate advisory firm, which merged with InterFinancial Limited (www.interfinancial.com.au) in 2005, where he is currently an Executive Director.

Introduction
! Exploration ! Resources and reserves ! Feasibility studies ! Mining methods ! Mineral processing ! Marketing ! Commodity-price forecasts ! Equity valuation

Exploration
Defining drill targets
Explore for economic mineralisation: Explore for economic mineralisation: structure, alteration, rock type, mineralisation structure, alteration, rock type, mineralisation

Review information Analyse data from the air, surface and subsurface Define most likely location for drillable target
Physical Physical properties properties

Geologic models: Geologic models: descriptive, genetic descriptive, genetic

Existing information Existing information

Remote sensing Remote sensing

Geochemistry Geochemistry

Regional geology Regional geology

Regional geophysics Regional geophysics for buried structure for buried structure

Drill to discover if orebody exists

Geologic interpretation Geologic interpretation

Generate drillable Generate drillable targets targets

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Some things to look out for

! ! ! ! ! !

Exploration near known economic occurrence Previous success Adequate money to be spent Depth and value of target Proximity to infrastructure Availability of water
Airborne magnetic survey

Exploration
! ! ! !

Obtain samples of the orebody at depth Determine the shape, size and location of the orebody Determine the ore density and grade distribution Rotary air blast (RAB) - least expensive but least reliable Reverse circulation (RC) - more expensive but more accurate

RC drilling

Exploration
!

Diamond drilling - most expensive but most accurate as core of rock recovered Core cut to provide samples for assaying and a competent piece for geological interpretation and geophysical tests

Underground Diamond Drilling

Copper strike - Drilling cores from end 06 at Einasleigh 50m @ 6.65% Cu from 235m
Core tray

Exploration
! ! !

Drilling designed to intersect orebody at right angles to get true width Often only the best results released Analysts need to interpret the results to get an idea of tonnage and grade

Average thickness is about 2.7 metres Total combined depth of mineralisation is about 210 metres Length along strike of mineralisation is about 150 metres Thus, 210m x 150m x 2.7m x 3SG = 255,000 tonnes With a weighted average grade of 28.4g/t gold equivalent
SG = specific gravity 7

Resources & reserves

Defining drill targets
Exploration results Mineral resources
Inferred Increasing level of geological knowledge and confidence Indicated Probable

Ore reserves

Increasing knowledge (primarily through drilling) and confidence move resources from inferred to measured and reserves from probable to proven Applying physical and economic factors moves a resource to a reserve A reserve usually results in higher grades but lower tonnage as subeconomic material is disregarded when computing the reserve Determination ultimately relies on a competent person who must have adequate experience in the type of mineralisation being quantified

Measured

Proved

Consideration of mining, metallurgical, economic, marketing, legal, environmental, social and governmental factors (the Modifying Factors").

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Classification guide
JORC Code Measured resource Indicated resource Inferred resource Previous Chinese Category A B C D New Chinese Category 111, 112, 121, 122, 2M11, 2M21, 2S22, 2S21, 331 2S11, 2S22, 332 333, 334

Source: Adapted from various company IPO Prospectus, CLSA Asia-Pacific Markets

Resources & reserves

Sample of drill holes
Hole No. Met-25 Met -26 Met-27 Met-1575 Met-15 Met-16 Met-17 Met-05 Met-06 Northing 10,200 10,200 10,200 10,150 10,100 10,100 10,100 10,000 10,000 Easting 500 600 700 750 500 600 700 500 600 Interval from - to (metres) 50-60 53-62 55-60 58-64 60-66 63-69 66-70 69-72 71-73 Intercept metres 10 7 5 6 6 6 4 3 2 Grade units/tonne 4.5 3.8 3.1 3.2 3.0 3.1 2.9 2.8 2.5

Met-26

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Met-15

Met-16

Met-17

Drill-hole plan
500E 10,200N 600E 700E 800E

Met-06

6 metre interval @ 3.1 g/t average

10,100N

10,000N
Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Resources & reserves

Mineral content
Hole No. Met-25 Met-26 Met-27 Met-1,575 Met-15 Met-16 Met-17 Met-05 Met-06 Total Volume (metres) 100,000 70,000 50,000 38,000 60,000 60,000 40,000 30,000 20,000 468,000 Tonnes 250,000 175,000 125,000 190,000 150,000 150,000 100,000 65,000 50,000 1,255,000 Grade (g/tonne) 4.5 3.8 3.1 3.2 3.0 3.1 2.9 2.8 2.5 Metal content (kg) 1,125 665 388 608 450 465 290 182 125 4,298

By determining the grade and tonnage for all blocks in the orebody, a distribution of grade vs tonnage can be derived as shown below
Cut-off grade = total cost/recovery/price per unit of metal = US$68.73/tonne/0.95/US$48.23/gram = 68.73/0.95/48.23g per tonne = 1.5g per tonne

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Ore grade distribution

35 30 25 20 15 10 5 0 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0
Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

(%)

The tonnage of ore above the 1.5g/t cut-off grade is 93% of the original tonnage, while the average grade of the remaining ore must increase The average grade increases from 3.2g/t of gold to 3.3g/t If the cut-off was 2.5g/t then the tonnage above cut-off would be 66.5% and the new grade would be 3.7g/t
10

Cut-off

! !

Ore grade (g/tonne)

Resources & reserves

Ore block grade determination
500E 10,200N 600E 700E 800E

Variogram: AU_azm180pln = 60
1.2 1.0 0.8 0.6 Variogram Y(h)

10,100N
0.4 0.2

10,000N
Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

0.0

Log distance (h) 0 2 4 6 8 10 12 14 16 18 20

Variogram

! ! ! ! !

Grade result for one hole over one metre might represent grade applied to 6000t of ore Better approach is to take the average or distance-weighted average of nearby grades Geostatisitics and the Kriging method optimally weight the nearby grades First determine if there is spatial correlation between the grades using a variogram Next solve simultaneous equations to minimise the error
11

Feasibility studies
Geology and ore reserves - Size, shape and depth of the ore, the grade of the ore and distribution, how homogeneous, any major faults or intrusions Mining method and schedule Surface, open cut, underground, annual production rate vs life of mine (High production rate, high capital expenditure, shorter mine life what is the optimum?) Metallurgy/concentrator/washery design Recovery factor, concentrate grade, product quality Water, power and environmental issues Source, capital and operating cost, disposal of tailings Permits Right to mine and discharge waste and make good Construction schedule Timing, how long to first production the quicker the better Construction cost Minimum expenditure to get the project operating, which varies depending on type and size of mine Markets and marketing Transport to market (FOB or CIF), price for product quality sold, secondary processing costs, adequate demand for product Financial analysis Put all of the above together to determine if the project is financially viable
12

Feasibility studies
Feasibility studies Back of the envelope (scoping study) Pre-feasibility Final/bankable feasibility Construction phase Cost $100,000s $m $10m variable Time months months year(s) year(s) Accuracy low fair good very good
can use rule of thumb

! Aim is to derive an economic valuation for

the project

Capital cost /annual production Black coal Copper Gold Iron ore Lead-zinc Nickel

(US$)

! Most common methodology relies on

determining the annual profit or cashflow later on capital and operating costs

10-95/tonne 875-1,350/tonne 165-1,250/ounce 10-75/tonne 250-860/tonne 4,000-6,000/tonne

13

! In early stages emphasis is on reserves,

Feasibility studies
Annual revenue Product sold x product price received = revenue (net of royalties, market costs, smelter & refining costs etc) (Need to determine the cashflow that the project gets from the sale of the product not the value in the ground) Annual costs Annual mining rate x mining cost per tonne = mining cost (adjust for stripping ratio, dilution, mine recovery etc) Annual milling rate x milling cost per tonne = milling or washing cost (milling rate <= mining rate) Annual mining rate x administration cost per tonne = administration cost Pretax cashflow Revenue less annual costs = pretax cashflow (may need to take account of interest if project geared) Cashflow Pretax cashflow less tax = cashflow (need to take account of allowable depreciation and adjustments for tax and any project debt repayments) Profit Cashflow less depreciation = profit after tax

14

Feasibility studies Scoping study

JUNE YEAR END 2008 2009 2010 2011 2012 2013

PRODUCTION
Mined Waste & LG S/Pile Ore Mined Ore From LG S/Pile Total (Tonnes) Waste to Ore Ratio Grades Copper High Grade Copper Low Grade Gold Grade Molybdenum Grade Contained Tonnes Copper Mill Recovered Copper/Au/Moly 4,067,000 30,000,000 30,000,000 30,000,000 30,000,000 933,000 18,000,000 18,000,000 18,000,000 18,000,000 0 0 0 0 5,000,000 48,000,000 48,000,000 48,000,000 48,000,000 1.67 1.67 1.67 1.67 0.602 0.26 0.02 0.004 0 0 0.60 0.26 0.02 0.004 113,977 96,880 96,880 213,524 376,756 358,815 1.11 459 10 $248,229 $238,299 $80 $28,705 $0.08 $17,607 $191,987 0.60 0.27 0.02 0.004 108,000 91,800 91,800 202,327 357,000 340,000 1.14 418 10 $241,683 $232,016 $80 $27,200 $0.08 $16,711 $188,104 0.55 0.26 0.02 0.004 99,000 84,150 84,150 185,467 327,250 311,667 1.15 399 10 $224,190 $215,222 $80 $24,933 $0.08 $15,363 $174,926 0.55 0.00 0.02 0.004 99,000 84,150 84,150 185,467 327,250 311,667 1.100 399 10 $215,844 $207,210 $80 $24,933 $0.08 $15,363 $166,914

CAPITAL COSTS ($000)

Site and General Utilities Process Plant Infrastructure Structures Tailings Mining Power Plant Construction indirects Freight EPCM Subtotal Indirects Ongoing Subtotal Ongoing Total Capital Cost Accumulated WORKING CAPITAL $112,089 $112,089 $251,635 $363,724 $3,000 $366,724 $0 $366,724 $3,382 $3,813 $34,596 $2,542 $13,627 $9,441 $0 $10,920 $14,639 $5,611 $13,517 $19,128 $6,281 $7,082 $64,250 $4,721 $25,307 $17,534 $55,056 $20,280 $27,186 $10,421 $13,517 $23,938 $0 $226 $226 $366,950 $400 $626 $626 $367,575

SMELTER TERMS AND METAL PAYMENT

Tonnes Copper Metal (lb 000) Tonnes Concentrate @ 5% mc @ Tonnes Concentrate dry Copper Price US$/lb Gold Price US$/oz Molybdenum Price US$/lb Gross Revenue Smelter Payment Treatment Charge US$/t Treatment Charge Refining Charge US$/lb Refining Charge Total Net Revenue ($000)

INCOME TAX CALCULATIONS

Net Smelter Return - Operating Costs + Salvage Sub-Total Net Income Net Income Before Depreciation - Depreciation Net Income Before Losses + Losses: Current Year Prior Years Taxable Income $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 ($112,089) $0 $0 $0 ($112,089) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 ($251,635) $0 $0 $0 ($251,635) $191,987 ($68,538) $0 $123,449 $123,449 ($55,009) $68,441 $0 $0 $68,441 $191,987 ($68,538) $123,449 ($5,760) $117,690 ($3,000) ($11,423) $0 $0 $103,267 $0 $103,267 $188,104 ($65,577) $0 $122,527 $122,527 ($55,009) $67,519 $0 $0 $67,519 $188,104 ($65,577) $122,527 ($5,643) $116,884 $0 $0 $0 $0 $116,884 $0 $116,884 $174,926 ($64,454) $0 $110,473 $110,473 ($55,042) $55,430 $0 $0 $55,430 $174,926 ($64,454) $110,473 ($5,248) $105,225 ($226) $0 $0 $0 $104,999 $0 $104,999 ($38,574) $166,914 ($65,515) $0 $101,400 $101,400 ($55,136) $46,263 $0 $0 $46,263 $166,914 ($65,515) $101,400 ($5,007) $96,392 ($626) ($177) $0 $0 $95,590 $0 $95,590 $57,015

OPERATING COSTS
Mining Cost Owner Total Mining Milling Labour Consumables Power Maintenance Total Milling General & Administration Admin & OH

($000)
$/tonne mined 0.379 $23,650 $1,657 $17,229 $15,826 $4,733 $39,445 $5,443 $68,538 $68,538 0.367 $22,901 $1,575 $16,380 $15,046 $4,500 $37,501 $5,175 $65,577 $65,577 0.349 $21,778 $1,575 $16,380 $15,046 $4,500 $37,501 $5,175 $64,454 $64,454 0.366 $22,838 $1,575 $16,380 $15,046 $4,500 $37,501 $5,175 $65,515 $65,515

PROJECT CASHFLOW ($000)

+ Net Smelter Return - Operating Costs = Profit Before Royalties Excise Tax = Profit After Royalties - Capital Costs + Working Capital + Salvage - Rehabilitation = "Gross Profits" (Cash) - Income Tax = "Net Profit" (Cash) Accumulated Cash

$/tonne $/tonne $/tonne $/tonne $/tonne

milled milled milled milled milled

$/tonne milled

Sub-Total Operating Costs Total Operating Cost

$0 $0 ($112,089) ($251,635)

($112,089) ($363,724) ($260,457) ($143,573)

Continues next right

15

Feasibility studies
NPV sensitivity analysis
200 NPV (US$m) Gold price Mining cost 150 Milling cost

! !

Consideration must be given to the risks associated with a project Sensitivity analysis shows the sensitivity of project economics to variation in critical parameter values Probability analysis defines distributions of likely outcomes for each critical variable and generates random NPVs to produce a probability distribution of the possible results

100

50 Change from base case (20%) (10%) 0% 10% 20% 30%

0 (30%)

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets 50 45 40 35 30 25 20 15 10 5 0 -8 4 16 28 41 53 NPV $m 65 77 89 101 114 0 40 60 Cumulative probability (RHS) 80 (%) Probability (LHS) 100 (%) 120

100%
Probability

0% min Gold price max

min
20

Milling cost

max

min

max Mining cost

16

Mining methods
Mining companies need to get access to the orebody
! If underground, by shaft or decline
! If near surface, by open cut

! If oil or gas, by pipe

Headframe

Open cut

Oil & gas exploration well

17

Mining methods
! ! !

May need to drill and blast waste rock and ore if it is too hard If an open cut, must move waste material to access economic ore Ratio of waste to ore can greatly affect the project economics

Drilling rig for blast holes

Open-cut cross-section
surface

mined ore blocks

1 mined waste block 2 3 waste block 4

ore blocks

Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Blasted zone in open cut

18

Mining methods - Mucking

Front- end loader and dump truck

Underground load haul dump (LHD) vehicle

Aim is to move dirt (waste or ore) as cheaply as possible, so economies of scale count Underground minimise dilution and maximise recovery, maintain support integrity while minimising costs
Electric shovel

19

Mining methods
Strip mining
next overburden cut waste surface

co al s e am
Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

Economies of scale allow large volume of waste or overburden to be moved

Dragline

Alluvial mining
suction cutter head dredge plant heavy mineral sands pond
Source: The Mining Valuation Handbook, CLSA Asia-Pacific Markets

waste

Moving the processing plant saves on transport and rehandling costs

Sand dredge

20

Mineral processing
! !

Physical reduction via crushing and grinding to allow liberation Concentration of mineral via separation from waste
ORE

Concentrator process

Primary crusher

Source: Falconbridge, CLSA Asia-Pacific Markets

Drying

Flotation cells

Grinding Rod-and-ball mills

21

Mineral processing
Smelting process !

Downstream smelting and refining

Source: Falconbridge, CLSA Asia-Pacific Markets

Gold pour

Issues
! ! ! ! !
Tailings dam Mine waste can be an environmental issue

Consumption of consumables Energy costs for grinding Mill recovery Adequate supply of water Disposal of tailings
22

Mineral processing
! Development of mine site
Tailings Water Mill Ore body Waste

requires statutory approvals and sufficient land tenements to allow for numerous onsite activities capital and operating costs

! Remoteness can impact

! Discharge and location of

waste and tailings storage can be a major issue

Site accommodation

Placer Dome - North Mara, Tanzania

23

Marketing
Chief saleable products
! Crude ore - Bauxite; iron-ore lumps and fines; unwashed coal;

limestone; clay

! Concentrated ore - Copper, nickel, lead, tin, zinc, tungstic oxide or

mineral-sand concentrates; washed coal; iron pellets; alumina; titanium oxide iron; hot briquetted iron; aluminium; ferro-alloys; coke

! Crude smelted ore - Blister copper; crude lead; nickel matte; pig ! Final refined product - Refined metals; steel ! Secondary or scrap - Steel scrap; scrap lead;

scrap copper; product aluminium scrap; recovered tin and silver

24

Marketing
Major minerals can be grouped into the following six classes depending on market and price characteristics
! Precious metals - Gold, silver and platinum ! Base metals - Aluminium, copper, lead, zinc, nickel and tin ! Steel and fuel minerals - Iron ore and coal ! Speciality metals - Ferro-alloys, magnesium, cobalt, bismuth,

tantalum and cadmium

! Hydrocarbons - Oil and gas ! Non-metallics - Salt, fertilisers and construction materials ! Other - Uranium, diamonds and mineral sands.

25

Marketing
Treatment terms
! Payable metal - Payability for the metal contained in the

concentrate typically varies from 70-95%. Any precious metals content may also be paid by percentage or net of a minimum deduction (the off), such as 1g/t gold or 50g/t silver. charge (pound of metal) can be quoted separately or as combined charge per tonne of concentrate or pound of refined metal. metal prices above and below a base rate. A typical formula may state US$0.02/lb copper for each 10% above US$0.90/lb.

! TC/RC - Treatment charge (tonne of concentrate) and refining

! Price participation - Added to the TC/RC so smelter participates in

! Refining & penalties - Other charges for payable gold can be of the

order of US$3-7 and for silver US25-50 per ounce. Penalties are varied and negotiable. For arsenic, an additional charge of US$3 for each 0.1% above 0.2% content in the concentrate may be payable.

26

Marketing
Treatment terms - Sample calculation
! Assume copper concentrate of 25% metal, and copper price of

US$2.00 per pound

! Therefore the gross value per tonne of concentrate is

US$2.00 x 540.5lbs = US$1,081/tonne US$1,033.4/tonne

! But the mine might only get paid for 95.6% of the metal content, or ! The treatment charge (TC) might be US$100/tonne of concentrate

and the refining charge US10/pound of copper, or a charge of US$152.7/tonne

! Assuming all other credits and charges net out to zero, the resultant

payment to the mine would be US$880.7/tonne or 81.5% of the original value

27

Marketing
! Forward markets allow sellers to hedge prices by selling products at a fixed price at

a certain date in the future

! Not all contracts require physical delivery. Those that do will set certain product

standards which need to be met

! Therefore commodities such as refined metal are more common than commodities

such as coal, which can be highly variable

LME aluminium forward price curve

2,530 2,510 2,490 2,470 2,450 2,430 2,410 2,390 2,370 2,350 0 3 Months 15 27 28 buyer seller (US$/t)

Commodity price forecasts

Price setters
!

Open-market price - Terminal buyers and sellers, traders Published price quotation - Sellers that report sales Producer price - One or more large producers Consumer price - One or more large consumers Contract price - Individual buyers and sellers Controlled price market - Guided by pools Fixed price - Governments

29

Commodity price forecasts

Aluminium intensity of usage
30 Japan 25 US

! New economies catch up

with increasing intensity of usage economies

kg per person

20

SKorea

! Synchronised world ! Old economies, more

15

10 Poland China 0 0 10000 20000 $ per capita 30000 40000

substitution likely

! Oil price still below 1980

real price level of around US$100/bbl account deficit

! US economy and current

30

Commodity price forecasts

Smelting process
1,800,000 1,600,000 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 Jan 00 SHFE Jan 01 LME Jan 02 Jan 03 COMEX Jan 04 Jan 05 Jan 06 (tonnes) (US$/tonne) 6,000 5,000 4,000 3,000 2,000 1,000 0 LME 3M Copper Price (RHS)

! Movements in inventory levels

can be a reasonable leading indicator of changes in commodity prices

! But not all world inventories are

identifiable, so terminal markets might decrease but fabricator inventories might increase The relationship between stocks and prices can be quite strong However the slope of the relationship and hence the price forecast can change as the market becomes more attuned to the changing situation

Source: Falconbridge, CLSA Asia-Pacific Markets

Scattergram of LME stocks and prices

6400 6200 6000 5800 5600 5400 5200 5000 4000 6000 8000 10000 12000 14000 Stocks (tonnes) Last eight months Price (US$/tonne) Previous eight months

31

Commodity price forecasts

1997 Supply (tonnes Sn) Bolivia Brazil Indonesia Malaysia Peru Thailand Other China exports CIS exports USA strategic Total supply Demand (tonnes Sn) USA IP growth (%) Japan IP growth (%) Germany IP growth (%) UK IP growth (%) France IP growth (%) Rest of Europe Other industrials Developing countries Total Reported stocks LME stockpiles Stock/demand (weeks) LME price (US$/lb) Actual price (US$/lb) 15,000 20,000 49,000 35,000 10,000 12,000 12,000 25,000 8,000 11,200 197,200 3,8325 5.0 28,003 4.1 20,384 4.0 10,748 1.4 8,404 3.8 22,000 6,500 51,000 185,386 45,889 11,000 12.9 2.55 1998 (est) 15,000 19,000 47,000 31,000 15,000 14,000 11,000 26,000 8,000 11,000 197,000 3,9706 2.3 28,507 1.8 21,077 3.4 10,877 1.2 8,618 2.5 23,500 6,500 53,000 1,917 48,491 11,624 13.1 2.55 2.48 1999 (est) 15,500 20,000 50,000 28,000 17,000 14,000 11,000 28,000 8,000 11,000 202,500 41,001 2.0 29,077 2.0 21,499 2.0 11,073 1.8 8,808 2.2 25,000 6,600 57,000 200,067 49,707 11,915 12.9 2.60 2.42 2000 (est) 16,000 21,000 52,000 23,000 20,000 14,000 10,000 29,000 8,000 11,000 204,000 42,321 2.0 29,659 2.0 21,929 2.0 11,295 2.0 8,984 2.0 26,000 6,700 60,000 206,896 48,259 11,568 12.1 2.70 2.42 2001 (est) 165,000 22,000 54,000 20,000 20,000 14,000 10,000 30,000 8,000 11,000 205,500 44,167 2.0 30,252 2.0 22,367 2.0 11,521 2.0 9,163 2.0 27,000 6,800 63,000 214,280 43,869 10,516 10.6 2.80 2.00

! Supply- and demand-side

forecasting aims to determine the likely change in inventory necessary to forecast mine expansions, closures and new developments necessary to estimate the likely growth in industrial production, which is a reasonable predictor of demand adequately predict growth in the China market has failed to foretell significant increases in commodity prices

! On the supply side it is

! On the demand side it is

! In recent times the failure to

32

Commodity price forecasts

! Quality differentials can

result in different prices for the same commodity usually set on a yearly basis such as coal, bauxite and iron ore

! Evergreen contracts are

! Most prices for bulk

commodities are on a free on board basis (FOB) at the port of loading

33

Equity valuation
Rio Tinto Resource projects currently producing profit and cashflow Resource prospects or deposits under current evaluation Exploration acreage which may provide prospects Other asset investments Less net debt Net asset value (NAV) Discounted cashflow, market comparable, market multiples Discounted cashflow, resource or reserve multiples Expenditure commitments, recent sale transactions, expected monetary value, other companies in same area Market or inferred valuation Financial accounts Sum of the above values US$68,000m US$7,200m

US$600m

US$120m US$1,050m US$74,870m

34

Equity valuation
! Determine future cashflow (negative and positive) on yearly basis - for the

company or a project

! Cashflow should be discretionary - that is, the amount generated from a project

after all costs, or the surplus funds that a company could pay its shareholders capital has to be deducted from the cashflow

! For a company or project, stay in business capital expenditure and working ! The resultant cashflow is then discounted by the appropriate discount rate ! WACC is the weighted average of the cost of debt and the cost of equity ! The cost of equity is the after-tax return expected for that class of company ! If a firm takes on a more risky project, the markets cost of equity might rise ! The internal rate of return (IRR) is the maximum rate of return achievable from

(hurdle rate) - for companies this is the weighted average cost of capital (WACC)

the cashflow

35

Equity valuation
! Price earnings ratio " Is the PE a surrogate for shareholder discretionary-cashflow ratio? " PE is used as a gauge for comparison against other similar companies " PE is a snapshot in time so there can be many reasons for differences between like companies ! Price to cashflow ratio - Avoids the vagaries of accounting, therefore

can be more reliable

! Enterprise value/Ebitda - Ungeared ratio that can provide a more

stable comparison between stocks

! Economic value added (EVA) Ultimately, very similar to NPV but

more meaningful for industrial stocks market cap

! Exposure to a commodity - Value of reserve or production per ! Option value - Value of exposure to commodity price volatility
36

Conclusion
What to look for
! Good management with plenty of experience getting resource

projects off the ground

! Strong ratio of exploration ground to firms size, in the right areas ! A successful exploration track record ! Projects with good grades and hence medium-to-high

value per tonne of ore - grade is king factors equal

! Open cut preferable to underground, if all other ! Companies with projects where production likely to

start in the near to medium term

37

CLSA U is an ongoing executive education programme designed to bring you firsthand information. Draw your own conclusions and make more informed investment decisions - all in a conducive learning environment reminiscent of university days.

Contact: Angelique Marcil at angelique.marcil@clsa.com

38

Notes

39

Research & sales offices

www.clsa.com Operational hubs
Hong Kong CLSA Hong Kong 18/F, One Pacific Place 88 Queensway Hong Kong Tel : (852) 2600 8888 Fax : (852) 2868 0189 Singapore CLSA Singapore 9 Raffles Place #19-20/21 Republic Plaza II Singapore 048619 Tel : (65) 6416 7888 Fax : (65) 6533 8922 USA Calyon Securities (USA) Inc Calyon Building 1301 Avenue of The Americas New York, New York 10019 Tel : (1) 212 408 5888 Fax : (1) 212 261 2502 United Kingdom CLSA (UK) 122 Leadenhall Street London EC3V 4QH Tel : (44) 207 696 9190

Fax : (44) 207 214 5401

Asia-Pacific Markets
China Beijing CLSA Beijing Unit 10-12, Level 25 China World Tower 2 China World Trade Centre 1 Jian Guo Men Wai Ave Beijing 100004, P.R.C. Tel : (86 10) 6505 0248 Fax : (86 10) 6505 2209 China Shanghai CLSA Shanghai Suites 305-310, 3/F One Corporate Avenue No.222 Hubin Road Luwan District, Shanghai PRC 200021 Tel : (8621) 2306 6000 Fax : (8621) 6340 6640 India CLSA India 8/F Dalamal House Nariman Point Mumbai 400 021 Tel : (91) 22 5650 5050 Korea CLSA Korea 15th Floor Sean Building 116, 1-Ka, Shinmun-Ro Chongro-Ku, Seoul, 110-061 Tel : (82) 2 397 8400 Fax : (82) 2 771 8583 Taiwan CLSA Taiwan 6/F, No. 117, Sec. 3 Min-sheng E. Road Taipei Tel: (886) 2 2717 0737

Fax : (91) 22 2284 0271

Fax: (886) 2 2717 0738

Indonesia CLSA Indonesia WISMA GKBI Suite 1501 Jl. Jendral Sudirman No.28 Jakarta 10210 Tel : (62) 21 574 2626/2323

Fax : (62) 21 574 6920

Malaysia CLSA Securities Malaysia Sdn. Bhd. Menara Dion, #20-01 27 Jalan Sultan Ismail 50250 Kuala Lumpur e (Company No. 690921-X) Tel : (603) 2056 7888 Fax : (603) 2056 7988

Thailand CLSA Securities (Thailand) Ltd 16th Floor, M. Thai Tower All Seasons Place 87 Wireless Road, Lumpini Pathumwan, Bangkok 10330 Tel : (662) 257 4600 Fax : (662) 253 0532

China Shenzhen CLSA Shenzhen Room 3111, Shun Hing Square Di Wang Commercial Centre 333 Shennan Road East Shenzhen 518008 Tel : (86) 755 8246 1755 Fax : (86) 755 8246 1754

Japan Calyon Securities Shiodome Sumitomo Building 15F 1-9-2, Higashi-Shimbashi Minato-ku, Tokyo 105-0021 Tel : (81) 3 4580 5533 (General) (81) 3 4580 8722 (Trading Floor) Fax : (81) 3 4580 5896

Philippines CLSA Philippines 18th Floor, Tower One The Enterprise Center 6766 Ayala Avenue Makati City Tel : (63) 2 860 4000 Fax : (63) 2 860 4051

Key to investment rankings: BUY = Expected total return greater than 10%; O-PF = Expected to outperform the local market by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%. Performance is defined as 12-month total return (including dividends). 2006 CLSA Asia-Pacific Markets (CLSA).
This publication/communication is subject to and incorporates the terms and conditions of use set out on the www.clsa.com website. Neither the publication/ communication nor any portion hereof may be reprinted, sold or redistributed without the written consent of CLSA. MICA (P) 051/12/2005. V. 060103. CLSA has produced this publication/communication for private circulation to professional and institutional clients only. The information, opinions and estimates herein are not directed at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so would be contrary to law or regulation or which would subject CLSA to any additional registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable. Such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness or correctness. Any opinions or estimates herein reflect the judgment of CLSA at the date of this publication/ communication and are subject to change at any time without notice. Where any part of the information, opinions or estimates contained herein reflects the views and opinions of a sales person or a non-analyst, such views and opinions may not correspond to the published view of the CLSA research group. This is not a solicitation or any offer to buy or sell. This publication/communication is for information purposes only and is not intended to provide professional, investment or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before acting on any information in this publication/ communication, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice, including tax advice. CLSA does not accept any responsibility and cannot be held liable for any persons use of or reliance on the information and opinions contained herein. To the extent permitted by applicable securities laws and regulations, CLSA accepts no liability whatsoever for any direct or consequential loss arising from the use of this publication/communication or its contents. Subject to any applicable laws and regulations at any given time CLSA, its affiliates or companies or individuals connected with CLSA may have used the information contained herein before publication and may have positions in, may from time to time purchase or sell or have a material interest in any of the securities mentioned or related securities or may currently or in future have or have had a relationship with, or may provide or have provided investment banking, capital markets and/or other services to, the entities referred to herein, their advisors and/or any other connected parties. Japan: This publication/communication is distributed in Japan by Calyon Securities Japan, a member of the JSDA licensed to use the CLSA logo in Japan. United Kingdom: Notwithstanding anything to the contrary herein, the following applies where the publication/communication is distributed in and/or into the United Kingdom. This publication/communication is only for distribution and/or is only directed at persons (permitted recipients) who are (i) persons falling within Article 19 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (the FPO) having professional experience in matters relating to investments or high net worth companies, unincorporated associations etc. falling within Article 49 of the FPO, and (ii) where an unregulated collective investment scheme (an unregulated CIS) is the subject of the publication/communication, also persons of a kind to whom the unregulated CIS may lawfully be promoted by a person authorised under the Financial Services and Markets Act 2000 (FSMA) by virtue of Section 238(5) of the FSMA. The investments or services to which this publication/communication relates are available only to permitted recipients and persons of any other description should not rely upon it. This publication/ communication may have been produced in circumstances such that it is not appropriate to categorise it as impartial in accordance with the FSA Rules. The analyst/s who compiled this publication/communication hereby state/s and confirm/s that the contents hereof truly reflect his/her/their views and opinions on the subject matter and that the analyst/s has/have not been placed under any undue influence or pressure by any person/s in compiling such publication/ communication.

MSCI-sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indicies. This information is provided on an "as is" basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by CLSA Asia-Pacific Markets. 22/05/2006