McCarthy P L, 1997.
Third Annual Australian Contract Mining Conference AIC
Conferences Pty Ltd, Sydney.
Conflicting Objectives – Mine Optimisation
and the Underground Contract
By P L McCarthy 1
Maximising the value of an underground mine to its owner
involves reducing the dilution of ore with waste rock and
following a well thought out plan. These objectives are not
necessarily those of the contractor and in fact may conflict with
the contractor's objectives.
My perspective is that of the originator of the feasibility study
for a new mine, who hopes to see it developed along sound
lines and to be as profitable for the owner as the feasibility
study predicted. I am also asked to prepare technical audits of
existing operations for the owners or often for lending banks. In
these situations the conflicting objectives of the owner and the
contractor are all too apparent.
A common complaint by the mine manager or the owner's
contract manager is as follows:
"These contractors are very good at development but don't
seem to handle the stoping as well. Whenever things get
difficult in the stopes, they just turn around and do more
development."
It is understandable that if the stoping gets difficult and less
profitable, then resources will be redirected towards the more
profitable activities. This can be very difficult for an
inexperienced contract manager to resist. The contractor will
argue that he isn't making money on the stoping and that it is
only fair that he be allowed to increase the development so that
the unpleasantness of possible latent conditions claims is
avoided.
In this presentation I have tried to quantify the conflicting
objectives of the mine owner and the contractor by working
through a case study for a small underground mine. The mine
budget is shown in the first column of Table 1. The owner plans
to mine about 500,000 tpa of diluted ore and to do 1,300 metres
per annum of development. Dilution is expected to be 10%. If
all goes to plan, the contractor's profit will be $1.7 M per year
and the owner's profit will be $7.3 M per year.
The lower part of the Table 1 budget shows the contractor's
income from development at a rate of $1,800 per metre and
from stoping at a rate of $30 per tonne. For simplicity, ground
support and other costs are assumed to be built into these rates.
1. MAusIMM, CPMin, Managing Director, Australian Mining
Consultants Pty Ltd, 19/114 William Street, Melbourne Vic 3000
E-mail: pmccarthy@ausmin.com.au
Now we know from a detailed analysis of costs at many mines
that the actual costs of development and stoping are no more
than 50% of these rates. The balance of the contractor's costs is
semi-fixed and is shown in the budget in Table 1 as a semi-
fixed cost of $7 M per year. I say the cost is semi-fixed because
it does in fact vary with the rate of mining activity but the
variation is much less than directly proportional. For this model
I have allowed the fixed cost to vary according to the 0.6 power
of the annual tonnage. That is:
New fixed cost = budget fixed cost
x
(new tonnage ÷ budget tonnage)0.6
This is a reasonable approximation which covers the additional
cost of services and the ownership of extra or larger equipment.
The bottom of Table 1 shows how the principal's profit is
derived. Assuming the resource grade of $70 per tonne, a
revenue figure is derived from which must be deducted the
mining cost (the contractor's charge), the treatment cost at $12
per tonne and administration at a fixed $1.2 M per annum.
The second column of Table 1 shows a forecast which may
have been prepared once the mine was up and running and it
was realised that the rate of mining the resource would be less
than expected. This could be due to geological surprises with
the orebody itself, difficult ground conditions or the inability
for some other reason to advance stopes as quickly as planned.
After dilution, the mining and treatment rate will be only
440,000 tonnes per annum. In this situation the contractor's
profit will be reduced to 77% of budget and the owner's profit
to 82% of budget.
The third column of Table 1 shows a situation where the budget
grade is not realised, although it is possible to mine at the
budget tonnage rate. The resource grade has dropped from $70
per tonne to $65 per tonne so that the owner's profit falls to
69% of budget. Of course the contractor is achieving budget
metres and tonnes so his profit is unaffected.
Conflicting Objectives – Mine Optimisation and the Underground Contract

Table 1 – Budget and forecast shortfalls

Physicals Rate Unit Budget Forecast Tonnage Shortfall Forecast Grade Shortfall

Development m 1,300 1,300 1,300

Resource Mined t 455,000 400,000 455,000
Dilution % 10 10 10
Ore Mined and Treated t 500,500 440,000 500,500
Contractor's Profit $ 1,677,500 1,290,713 1,677,500
Owner's Profit $ 7,289,000 5,980,000 5,014,000
Contractor's Profit 100% 77% 100%
Owner's Profit 100% 82% 69%
Contractor
Developer Income $1,800 m 2,340,000 2,340,000 2,340,000
Stoping Income $30 t 15,015,000 13,200,000.00 15,015,000
Total Income 17,355,000 15,540,000 17,355,000
Development Cost $900 m 1,170,000 1,170,000 1,170,000
Stoping Cost $15 t 7,507,500 6,600,000 7,507,500
Semi-fixed Cost $7,000,000 LS 7,000,000 6479287 7,507,500
Total Cost 15,677,500 14,249,287 16,185,000
Profit 1,677,500 1,290,713 1,170,000
Owner
Resource Grade t $70 $70 $65
Revenue From Resource t 31,850,000 28,000,000 29,575,000
Mining Cost 17,355,000 15,540,000 17,355,000
Treatment Cost $12 t 6,006,000 5,280,000 6,006,000
Admin Cost $1,200,000 LS 1,200,000 1,200,000 1,200,000
Profit 7,289.00 5,980,000 5,014,000

Table 2 shows possible responses by the contractor to a
shortfall in tonnage. Leaving everything else constant, he can
increase the development rate to 1,730 m per year. The extra
profit derived from the additional development will bring him
back to his budgeted profit (Column A). Alternatively he can
leave the development alone but increase the mining dilution.
This is done by reducing the care taken with production,
drilling and blasting and perhaps deliberately overbreaking into
waste rock on the hangingwall. If the dilution is increased to
25%, then the budget mining tonnage is restored and his
contract returns to budget profit (Column B). Note that by
increasing development, the contractor reduced the owner's
profit to 57% and by increasing dilution, he reduced the owner's
profit to 47% of budget. A realistic approach from the
contractor's point of view might be to increase development to
1,450 m per year and to increase dilution to 20%. The
combination of the two effects restores him to 100% profit
(Column C). This is not just a hypothetical example but I
believe I have seen the results of it at several mines which I
have examined.
The owner's perspective is quite different. He can restore
profitability by reducing the amount of development to cut his
costs. In Table 3, the development is reduced to 590 m per year
and the owner's profit is restored while the contractor's profit is
reduced to 39% (Column A). Alternatively the owner can leave
development alone but try to reduce dilution. If dilution could
be reduced to 2% (an impossibility in practice) then the owner's
profit would be restored while the contractor's profit was
reduced to 65% of budget (Column B). A likely compromise by
the owner would be to cut development to 850 m per year and
to try to improve dilution from 10% to 7%. This would bring
him back to budgeted profit but would reduce the contractor's
profit to 48% of budget (Column C). In the long term of course,
it is impossible to cut back on the amount of development
required, particularly if it is a response to a reduced availability
of resource. However this could well be an owner's strategy for
a single year if the problem was thought to be a temporary one.
The conflicting objectives of the owner and contractor are
highlighted in the above examples. The practical mining
strategies to be adopted underground work in quite opposite
directions if the contractor or the owner is to restore his
profitability to budget. With the current popularity of partnering
arrangements, one possibility might be to operate an open book
(agreed profit) contract. In Table 4, the contractor's profit is
locked in at its budget figure by means of an adjustment shown
in the contractor's income. With the contractor's profit fixed, we
only need worry about the owner's optimisation of the project.
Column A shows that even if the development was cut to zero,
the owner can achieve only 93% of his budgeted profit. If
development is held at budget but the dilution is cut to zero, the
owner's profit is 96% of budget (Column B). Taking the
practical compromise suggested in Column C (850 m of
development and 7% dilution) the contractor's profit remains at
budget while the owner's profit is 88% of budget.

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Conflicting Objectives – Mine Optimisation and the Underground Contract

Table 2 – Contractor’s response to shortfall in tonnage

Physicals Rate Unit Budget Forecast Tonnage Shortfall Forecast Grade Shortfall
Development m 1,730 1,300 1450
Resource Mined t 400,000 400,000 400,000
Dilution % 10 25 20
Ore Mined and Treated t 440,000 500,000 480,500
Contractor's Profit $ 1,677,713 1,677,197 1,678,465
Owner's Profit $ 5,206,000 3,460,000 4,030,000
Contractor's Profit 100% 100% 0%
Owner's Profit 71% 47% 55%
Contractor
Developer Income $1,800 m 3,114,000 2,340,000 2,610,000
Stoping Income $30 t 13,200,000 15,000,000 14,400,000
Total Income 16,314,000 17,340,000 17,010,000
Development Cost $900 m 1,557,000 1,170,000 1,305,000
Stoping Cost $15 t 6,600,000 7,500,000 7,200,000
Semi-fixed Cost $7,000,000 LS 6,479,287 6,995,803 6,826,535
Total Cost 14,636,287 15,665,803 15,331,535
Profit 1,677,713 1,674,197 1,678,465
Owner
Resource Grade t $70 $70 $70
Revenue From Resource t 28,000,000 28,000,000 28,000,000
Mining Cost 16,314,000 17,340,000 17,010,000
Treatment Cost $12 t 5,280,000 6,000,000 5,760,000
Admin Cost $1,200,000 LS 1,200,000 1,200,000 1,200,000
Profit 5,206,000 3,460,000 4,030,000

Table 3 – Owner’s response to shortfall in tonnage

Physicals Rate Unit Budget Forecast Tonnage Shortfall Forecast Grade Shortfall
Development m 590 1,300 850
Resource Mined t 400,000 400,000 400,000
Dilution % 10 2 7
Ore Mined and Treated t 440,000 408,000 428,000
Contractor's Profit $ 651,713 1,097,704 812,324
Owner's Profit $ 7,258,000 7,324,000 7,294,000
Contractor's Profit 39% 65% 48%
Owner's Profit 100% 100% 100%
Contractor
Developer Income $1,800 m 1,062,000 2,340,000 1,530,000
Stoping Income $30 t 13,200,000 12,240,000 12,840,000
Total Income $ 14,262,000 14,580,000 14,370,000
Development Cost $900 m 531,000 1,170,000 765,000
Stoping Cost $15 t 6,600,000 6,120,000 6,420,000
Semi-fixed Cost $7,000,000 LS 6,479,287 6,192,296 6,372,676
Total Cost $ 13,610,287 13,482,296 13,557,676
Profit $ 651,713 1,097,704 812,324
Owner
Resource Grade t $70 $70 $70
Revenue From Resource t 28,000,000 28,000,000 28,000,000
Mining Cost 14,262,000 14,580,000 14,370,000
Treatment Cost $12 t 5,280,000 4,896,000 5,136,000
Admin Cost $1,200,000 LS 1,200,000 1,200,000 1,200,000
Profit $ 7,258,000 7,324,000 7,294,000

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Conflicting Objectives – Mine Optimisation and the Underground Contract

Table 4 – Tonnage shortfall with agreed profit contract

Physicals Rate Unit Budget Forecast Tonnage Shortfall Forecast Grade Shortfall
Development m 0 1,300 850
Resource Mined t 400,000 400,000 400,000
Dilution % 10 0 7
Ore Mined and Treated t 440,000 400,000 428,000
Contractor's Profit $ 1,677,500 1,677,500 1,677,500
Owner's Profit $ 6,763,213 7,033,343 6,428,824
Contractor's Profit 100% 100% 100%
Owner's Profit 93% 96% 88%
Contractor
Developer Income $1,800 m 0 2,340,000 1,530,000
Stoping Income $30 t 13,200,000 12,000,000 12,840,000
Adjustment 1,556,787 626,657 865,176
Total Income 14,756,787 14,966,657 15,235,176
Development Cost $900 m 0 1,170,000 765,000
Stoping Cost $15 t 6,600,000 6,000,000 6,420,000
Semi-fixed Cost $7,000,000 LS 6,479,287 6,119,157 6,372,676
Total Cost 13,079,287 13,289,157 13,557,676
Profit 1,677,500 1,677,500 1,677,500
Owner
Resource Grade t $70 $70 $70
Revenue From Resource t 28,000,000 28,000,000 28,000,000
Mining Cost 14,756,787 14,966,657 15,235,176
Treatment Cost $12 t 5,280,000 4,800,000 5,136,000
Admin Cost $1,200,000 LS 1,200,000 1,200,000 1,200,000
Profit 6,763,213 7,033,343 6,428,824

The compromise outcome in Table 4 might seem reasonable if
the shortfall in tonnage was in no way the fault of the
contractor. In that case the owner should bear the responsibility
of his inadequate geological assessment and accept the lower
profit. However, to the extent that the shortfall is due to poor
performance by the contractor or his inadequate assessment of
ground support requirements and time necessary, then the open
book agreed profit scheme remains unfair.
possible for both contractor and the owner to achieve their
objectives without penalising one or the other. This is done in
effect by taking the excess profit from the contractor and giving
it back to the owner. The contractor still achieves his budget
profit and the owner finds it easier to achieve his budget profit
despite the adverse grade. This can be achieved at 605,000
tonnes mined and treated with 10% dilution (Column A) or at
681,000 tonnes mined and treated at 15% dilution (Column B).

The situation with a shortfall in grade is different, and Table 5
shows the owner's options. He can increase the tonnage mined
and treated to 682,000 tonnes and at the same time, increase the
development to 1,771 metres in order to access the additional
stopes needed. This restores his profit but increases the
contractor's profit to 202% (Column A). The contractor's profit
has gone up because of the additional work being done with a
large component of fixed cost.
In chasing a higher tonnage, the owner may acknowledge that
control of dilution will be somewhat relaxed. A realistic target
is shown in Column B where 15% dilution leads to an even
greater mining and development rate. Now the owner's profit is
restored but the contractor's profit has increased to almost
300%. Column C Table 5 shows the result of reducing dilution
from 10% to 7% while increasing the resource mining rate.
This increases the contractor's profit to 169% of budget. Table
5 shows the unfairness of a situation where the owner is in
difficulties and any action he takes will result in an increase of
profit for the contractor. Again this is a realistic and frequent
situation where the ore reserve grade is not achieved in practice
once the mine is opened up.
Table 6 again shows the open book (agreed profit) approach to
the mining contract. In the case of unrealised grade, it is
The above examples are hypothetical but the principles
illustrated are at work within every mining contract. With the
trend to out sourcing, mining companies are increasingly giving
control of the mining process to contractors. Who will take
responsibility for long term planning, scheduling and dilution
control so that the owner's objectives are met? If the contractor
becomes involved in these areas, then whose profit is he trying
to maximise? As the mining process becomes the responsibility
of contractors, mining engineers will gain their operational
experience with contractors rather than with mine owners. They
will absorb operational strategies which meet the contractor's
objectives but are in conflict with the owner's objectives. How
will they perform when they become planning and scheduling
engineers or contract administrators?
In the hypothetical case of a mining contractor who bought a
mine and attempted to run it himself, how would he perform? I
suspect that he would do the development very well and
probably exceed the budget metres every month. He would get
the stope tonnes although they would be more diluted than the
feasibility study predicted. By all his normal measures of
performance, he would be doing very well; but would the mine
be profitable?

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Conflicting Objectives – Mine Optimisation and the Underground Contract

Table 5 – Owner’s response to a shortfall in grade

Physicals Rate Unit Budget Forecast Tonnage Shortfall Forecast Grade Shortfall
Development m 1771 2100 1700
Resource Mined t 620,000 735,000 575,000
Dilution % 10 15 7
Ore Mined and Treated t 682,000 845,250 615,250
Contractor's Profit $ 3,396,253 4,982,545 2,835,806
Owner's Profit 7,267,429 7,294,500 7,274,500
Contractor's Profit 202% 297% 169%
Owner's Profit 100% 100% 100%
Contractor
Developer Income $1,800 m 3,188,571 3,780,000 3,060,000
Stoping Income $30 t 20,460,000 25,357,500 18,457,500
Total Income 23,648,571 29,137,500 21,517,500
Development Cost $900 m 1,594,286 1,890,000 1,530,000
Stoping Cost $15 t 10,230,000 12,678,750 9,228,750
Semi-fixed Cost $7,000,000 LS 8,428,033 9,586,205 7,922,944
Total Cost 20,252,318 24,154,955 18,681,694
Profit 3,396,253 4,982,545 2,835,806
Owner
Resource Grade t $65 $65 $65
Revenue From Resource t 40,300,000 47,775,000 37,375,000
Mining Cost 23,648,571 29,137,500 21,517,500
Treatment Cost $12 t 8,184,000 10,143,000 7,383,000
Admin Cost $1,200,000 LS 1,200,000 1,200,000 1,200,000
Profit 7,267,429 7,294,500 7,274,500

Table 6 – Grade shortfall with agreed profit contract

Physicals Rate Unit Budget Forecast Tonnage Shortfall

Development m 1571 1691
Resource Mined t 550,000 592,000
Dilution % 10 15
Ore Mined and Treated t 605,000 680,800
Contractor's Profit $ 1,677,500 1,677,500
Owner's Profit $ 7,279,734 7,279,482
Contractor's Profit 100% 100%
Owner's Profit 100% 100%
Contractor
Developer Income $1,800 m 2,828,571 3,044,571
Stoping Income $30 t 18,150,000 205,424,000
Adjustment (968,305) (1,637,654)
Total Income 20,010,266 21,830,918
Development Cost $900 m 1,414,286 1,522,286
Stoping Cost $15 t 9,075,000 10,212,000
Semi-fixed Cost $7,000,000 LS 7,843,480 8,419,132
Total Cost 18,332,766 20,153,418
Profit 1,677,500 1,677,500
Owner
Resource Grade t $65 $65
Revenue From Resource t 35,750,000 38,480,000
Mining Cost 20,010,266 21,830,918
Treatment Cost $12 t 7,260,000 8,169,600
Admin Cost $1,200,000 LS 1,200,000 1,200,000
Profit 7,279,734 7,279,482

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