PAPUA NEW GUINEA UNIVERISTY OF TECHNOLOGY

MINING ENGINEERING DEPARTMENT

PRIVATE MAIL BAG, TARAKA CAMPUS,
LAE 411, MOROBE PROVINCE, PNG
Ph: 4734671:

COURSE FACILITATOR
DR KAEPAE KEN AIL (PHD)

FEB 27TH 2023

 SESSION 1: OUTLINE

 MINING CYCLE AND PRODUCTION SYSTEMS

 STAKEHOLDER INTEREST’S
 OBJECTIVES OF GOVERNMENT AND MINING COMPANIES
 STRATEGY FOR GROWTH IN THE MINING INDUSTRY
 RESOURCE SECTOR FINANCE
 OBJECTIVES OF FINANCIAL EVALUATION
 MARKET STRUCTURE, PRICE CYCLES AND PREDICTIONS
 REGULATORY AND POLITICAL RISKS
 SUMMARY
Financial evaluation occurs here
 THE MINING CLYCLE

Royalties and tax

revenues to government
& communities
Economic rent (profit) to investors and
shareholders

Refinery/Market
NSR REVENUE
FLOWS Providers of inputs to
production and capital
owners
 MINING CYCLE

Haul
Rehabilitation
Drill

Blast
Load
Surface Mining
Underground Mining
UG Mining Cycle
 EVERY STAKEHOLDER HAS A FINANCIAL OBJECTIVE

 At the enterprise level means: continuing financial profitability, solvency and liquidity,
payout dividends and market performances

 Shareholders seek higher ROA in form of dividends

 To customers – lower prices, high demand and high market share

 To employees – higher wages and rewards, better working conditions and higher job
security

 To the state – higher tax revenues, royalty and fees, and maximise contribution to
economic activity, higher exports and GDP.
 GOVERNMENT’S INVOLVEMENT

Government involves heavily in exploration, construction and production of mineral

commodities through legislation and regulation because:
 Government owns the minerals, thus, it is obliged to make laws to control extraction
 The extraction is highly technical (engineering designs) that is capital intensive, high risks
and costs and can affect workers, investors reputation, and surrounding communities;
 Minerals are associated with toxic elements (sulfur) and chemicals (arsenic). Thus, mine
waste must be controlled to ensure environment is safe and regulations are in place to
restrict production of uranium as it can be used for military purposes)
 The negative impacts may last for decades after a mine closure
 Policies must be in place to ensure the nation and community benefit from extraction of
natural resources
 Precious minerals like gold, diamond and rare gem stones are legislated to control conflicts,
arms trade, transnational money laundering and corruption
 Fiscal regimes to capture revenues from the export of minerals to develop its economic,
financial and social infrastructure
 STAKEHOLDER INTERESTS

A primary purpose of legislating and regulating the industry is to control differing interests of
participating stakeholders:

1. Government has the ultimate power to legislate and enforce laws to ensure the points in
previous slide are executed to meet resource development policy.
2. Mining companies are licensed to extract minerals so that financial and economic benefits can
be shared and distributed to different benefactors. Governments can become part-owners
through SoEs having equity interests.
3. Lenders provide the capital for mine exploration and development, and thus, mining companies
are obliged to pay back the capital invested with interest to capital owners.
4. Factor providers: mining companies employ the providers of inputs to production (machines,
equipment, explosive, fuel, labour, etc.) for their service in production.
5. Employees: mining companies need to look after employees’ needs and government makes
employment laws for the industry to follow labour regulations (payroll taxes, FIFO, human
resource nationalisation)
6. Landowners (community) – investors and governments make commitments through MoAs to
meet infrastructure, redistribute benefits, and meet economic and social needs of host
communities
 STAKEHOLDER INTERESTS

 Provincial governments being custodian of the people are involved in monitoring and
administration and benefit redistribution processes. In PNG’s case, many PGs want to have direct
equity shares in projects as they are not allowed to collect royalties and income taxes (centralized
fiscal system).
 State agencies such as CEPA, DMPGM, MRA, MRDC, KMHL, IRC, EITI, National Planning and
Labour & Employment Departments are linked to the mining industry in various ways and play
critical roles in regulating, compliance auditing and benefit collection and distribution.
 NGOs like Mine Watch, OXFAM, Global Witness and others also contribute to effective regulation,
compliance auditing and impact related issues. They mainly exist as “whistle-blowers”.
 Some scientific NGOs participate in research and development (e.g., CSIRO) are often engaged
to undertake independent technical assessments and others are directly involved in sustainable
development planning and programs in mining regions
 Transnational organizations like the World Bank and IMF make global standard guidelines,
policies and regulations for the mining industry to contribute to national growth, social and
environment sustainability, poverty reduction and climate change.
 Justice Department provides a common ground to ensure the rule of law is maintained by
legislating and ensure regulations are administered effectively and fairly.
 PRIVATE COMPANIES’ CORPORATE POLICY AND OBJECTIVES

i) At the single project/investment level:

- Maximise the value of the project to the benefit of current shareholders and capital owners
- Short-term cash budgeting
- Long-term financial plan and asset procurements
- Current and non-current asset inventory and accumulation
- Current and long-term liabilities to meet long-term and short-term financing needs of the core
business activity

ii) Make investment decisions (At the Corporate level)

- Investment decisions based on financial capacity of the firm

- Either to invest on 100% equity financing; or
- Debt financing or a combination of both to enhance return on equity (ROA)
- And to achieve portfolio effects
- These are based on whole-of-life evaluation expressed in real or nominal financial terms (e.g.,
discounted cash flows)
iii) Maximising the financial value by optimizing cash flows through
- Maximise inflows (increase quantity, improve quality and fetch higher prices)
- Accelerate inflows (fast sale of inventories and short-term revenue receipts)
- Minimize outflows (e.g., reduce operating costs)
- Defer outflows (e.g., defer tax liabilities and long-term debts)

iv) At an integrated single company level:

- Maximise financial returns to shareholders from portfolio of projects and other acuities through
a complex interplay of:
- Long-term profitability, solvency and liquidity (efficiency and effectiveness)
- Growth, and survival (find new reserves to reverse the known reserves depleting
- Increase shareholder’s equity

v) At an industry level:
- Chase projects that are larger reserves (e.g., Newcrest’s Wafi-Golfu project)
- Look for acquisitions (Barrick acquired the Porgera gold mine in 2006)
- Forego small projects (which could commit resources, time and efforts for little financial
rewards (e.g., Barrick disposed K92 mine)
- Aim for lager cash flow projects
- Medium to long-life projects
- Choose to invest in projects that have higher to moderate rate of return.
 BUSINESS DEVELOPMENT STRATEGY CHART

 Growth horizons
Horizon 3: create viable options
(acquire mines/exploration - farmout)

Profit
Horizon 2: Build emerging business (vertical
integration through farmin)

Horizon 1: Extend and defend core business

Time (years)

 The three growth horizons are devised to defend the core business, develop
emerging businesses and create options for new business options. A firm has to be
capable of doing these three growth horizons in parallel. For example, Newcrest
extends and defend the Lihir gold mine as a core business and hopes to develop the
Wafi-Golpu project as an emerging business in the copper sector while creating
viable options in other countries (e.g., Gosowong, Indonesia).
 STRATEGIC EFFECTS OF GROWTH
 To maintain its rate of growth the firm is compelled to:
 - Chase larger minimum targets (e.g., Frieda River, Wafi-Golfu and Yandara type
deposits)
 - Look for acquisitions (farmin) by targeting low cost operations (e.g., Porgera gold mine)
 -Mining firms look for acquisitions rather than greenfield exploration that are mostly
done by junior exploration firms
 -Foregoes small projects (e.g., Barrick dispose of Tolakuma and Kainantu gold mines
may have low takeover/farmin) targets
 - Farmout large exploration properties by large firms (e.g., Frieda – deposit)
 The objectives generally aim for large annual cash flows
 Medium to long life mining projects
 Settles for more stable and moderate rate of return (ROR)
 A COMPANY THAT IS NOT SHOWING SIGNS OF GROWTH HAS NO LONG-TERM
INTEREST
 RESOURCE SECTOR FINANCE
4. Private Enterprise’s Corporate Financial Policy and Objectives

At a single investment level:

- Maximise project value to ensure all stakeholders (investors, input suppliers, government
and community) benefit from extraction activities

At a single integrated company level

- Maximise financial returns to shareholders from a portfolio of projects and other
investment activities such as exploration

At the corporate level

- maximise profit for shareholders, compete for market position and focus on future growth

These objectives exists within a complex interplay of:

- Long-term profitability, solvency and liquidity (efficiency and effectiveness)
- growth horizon and,
- Survival (continued exploration to increase reserves) and government plays its role by
creating competitive tax environment
 FINANCIAL PLANNING AND MODELS

 1. Financial analysis at the whole of enterprise level

 Short-term cash budgeting, i.e., income projection and expenditure planning
 Long-term up to 5 or 10 year financial plans that could involve capital expenditures such as
the case in horizon 2.
 Assumes on-going entity (going concern) and year-by-year results are expressed according
to historical financial accounting conventions using historical financial transaction data

2. Single project evaluation purely for investment decision-making

 To invest or not to invest decisions based on 100% equity financing models but realistic ones
could involve equity/debt capital cost finance models
 How to finance a project to enhance return on equity (ROE) by considering debt to equity
financing arrangement (often controlled by thin capitalisation rules)
 To achieve portfolio effects in which the opportunity cost of investing in the present option
must be offset quickly to decide on the next opportunity that may exist in future. This is
measured by normal rate of return (ROR) or discounted payback period in years at a
discount rate.
 WHOLE OF LIFE FINANCIAL OBJECTIVE

 At the project level, maximising financial value means

 (1) Optimising cash flows
 - Maximise inflows (high productivity)
 - Accelerate inflows (access to immediate sale receipts)
 - Minimize outflows (e.g., reduce operating cost)
 - Defer outflows (e.g., defer liabilities such as tax and long-term debts)

 At an initial project evaluation phase, financial decisions are measured by:

 - Net Present Value (NPV)
 - Internal Rate of Return (IRR)
 - Discounted payback period (DPBP)
 - Capital efficiency (KE) factor
 - Minimise risks and rational risk-return trade-offs
 Summary of objectives

Government’s fiscal objectives Investor’s financial objectives

 Maximise tax revenues  Maximise owner’s equity
 Attract foreign direct investment  Attain a positive NPV
 Equitable impact and value distribution  Shorter payback period
 Allocative and technical efficiency  Cost competitiveness
 Administrative efficiency  High productivity and market
position
NPV

RISK
REDUCTION

Payback
IRR (KE)
period
 FINANCIAL MODELING OF MINING PROJECTS
 Financial evaluation is a techno-economic model because:
 - mineral deposit is said to be financial viable if they have the capacity to generate
cash flows

 - a technical study component has to come first: feasibility study of mining method,
milling and social and environmental impacts

 - next, a financial component which investigates the cash flows are sufficient (given
price, capital and operating costs) to meet operational liabilities (e.g., capital and
wages and taxes) and still generate a profit.

 A financial model covers two phases

 - pre-production phase (10 – 15 years of exploration and feasibility study) leading to
construction after government permits such as SML are sorted out.

 -Production phase lasting over the anticipated life of the mine, which is determined
by the production rate (throughput) until the reserve is depleted.
 USES OF PRELIMINARY EVALUATIONS

 Project evaluations are used for:

 - investment decision to assess economic and financial worth of a mining project for
both 100% equity and combination of equity/debt capital investment
 - Financing decisions to determine the financial viability of a mine to attract capital
owners (equity and debt providers) to finance the mining operation.
 - Portfolio decision to determine the project in light of the firm’s investment and
corporate objectives and strategies.

 Preliminary evaluations will be sufficient to:

 - Estimate the viability/profitability and rank different options to allocate capital for a mine
development and exploration
 - Identify which risk factors are sensitive and determine the economic life of the mine
 Given geological conditions
 Negotiate from market and price accessibility
 Negotiate acquisitions, project sale, or JV agreements (farmin/farmout)
 Evaluate firm shares, takeover and mergers, taxation, liquidation and share floats
 Analyse risk sensitivity of the project
 INDUSTRY’S MARKET STRUCTURE
A clear knowledge of industry’s market structure is important for making laws, regulatory policy and
guidelines:

Competitive market: companies are price takers and enter the industry when there is an
opportunity to make a profit and build a market base. They exit the market if there are no profit-
making opportunities, especially during low prices. They survive by creating barriers to entry (product
differentiation & high marketing and complex value-chain network & government protection).
Government creates a market failure (e.g., Oil Search used GoPNG to raise capital to acquire an
interest in gas projects). All producers are in this category, and most mineral legislation and
regulation focus on the competitive structure.

Monopoly: a single producer controls outputs to manipulate the price (e.g., OPEC). There are no
cartel producers or organizations existing in the mining industry, though many have attempted but
failed. The industry competitive complicates the entry of a monopolist into the mining industry.

Duopoly: two suppliers can collude to behave as a monopolist producers (e.g., Newmont- 5.8 MOz
and Barrick – 4.8 MOz can acquire AngloGold Ashanti- 3 MOz, Polyus – 2.8 MOz and Kinross Gold –
2.4 Moz) to form a duopoly. Legislation and regulation of monopoly and duopoly could be complex.
But in a competitive market, the price and the quantity produced are controlled through domestic
legislation.
 What drives mining as an economic activity
The existence of economic rents drive companies to explore and extract the minerals

Rent is a neoclassical concept with reference to payments made to landholders for possessing
collateral rights to agricultural lands, which include mineral property rights. However, classical
economists argue that in-situ mineral has no value without a sacrifice (Tilton 2004)
Ricardian rent is an economic rent available to different mines (mineral types) as a result of
differences in costs, prices and deposit qualities (Tilton 2004). A government setting different tax rules
for different types of mineral extraction may target the Ricardian rents. E.g., Australia devised the RSPT
to capture Ricardian rents from iron ore sector (high profit) and thus, burdening a low profit sector (e.g.,
bauxite). This tax policy causes fiscal bias against marginal and low profit coal mines.
Parentian rent, economic rent and pure rent (all have same meaning) – defined as “the excess of
the return to a factor of production above the amount that is required to sustain the current use of the
factor (or to entice the use of the factor” (Ergas, Harrison and Pincus 2010). The economic rent is also
referred to as pure profit, or excess profit. The economic rent is taxable, where the “excess profits” that
is considered to be above the normal rent (Garnaut 2010b) are also subject to tax (APT).

Normal rent is defined as the “minimum rate of return required to hold capital for the activity” (Hogan
and Goldsworthy 2010, 135) or inflows before reaching the capital cost are normal rents
Quasi-rents are sunk and capital costs and operating costs available to suppliers of inputs to
production. The quasi-rents must not be taxed (including interest on debt capital)
 Source: Tilton (2004), Otto et al. (2006) and Garnaut and Ross (1983). There are variations in Fig. 1b from Tilton (2004).

Fig. 1a Ricardian rent and user costs from Fig. 1b Categories of rents for a single mine
industry perspectives.
 What drives mining as a economic activity

A profit is made by managing the variations in price, capital and operating costs, and deposit quality
etc. to maximise the economic rent

1. The value of metal output from a refinery is expensed against transport and handling costs,
smelting and refining costs – Gross revenue

2. Market conditions like supply and demand and price disturbance (strikes, wars, geopolitical
upheaval, legislative changes and disasters), drive price up or down depending on demand
conditions.

3. A price cycle is such that a prolonged low price causes a shortage of supply (existing mines may
close, no new mines developed, exploration decline). This triggers an increase in demand, that cause
a price to increase (e.g., 2003 – 2007). In that period, the mineral prices peaked (exploration picked
up and re-open closed mines). As this happens over time, an oversupply occurs, which entices
importers turn to stockpiles and recycled metals. It in turn causes the demand to decline and, thus,
the price to an initial condition of the cycle. This is called a price cycle.
4. A price upswing can cause changes to existing mineral legislation and policies as governments try
maximise revenues – why? A previous tax system may not capture enough revenues for communities
and thus, governments may insert new laws to maximize resource revenues
 PRICE CYCLE: 5-10 years

After economic
cycles have peaked
as indicated by a
sustained reversal
in the rate of A market oversupply
growth in industrial causes prices drop,
outputs leading to slow down
in production (no new
High supply mines develop and
low demand
dampen exploration). and high price

-price disturbance
cause by geopolitical
tensions (e.g., terrorists)
Low supply Low supply

Time (stockpilling ore and hedging strategies)

 PRICE PREDICTIONS

Three main price drivers: (1) fast macroeconomic growth in OECD countries, (2) high demands from
China and (3) speculative activity due to price disturbances. However, increasing population and food
shortages causes an emerging long-run demand growth for industrial minerals, (e.g., phosphate
needed for fertilizer production will trigger the demand for lime).
Mineral price forecasts up to 2025 and 2030:
Hydrocarbon: (1) Crude Oil (US$251.42/TOE; (2) LPG (US 6.9/MBtu, (3) LNG (US$ 6.8 /MBtu)
Metallic minerals: (1) copper (US$ 12,341.88/ton); (2) nickel (US$ 41,970/ton); (3) iron ore (US$
247.26/ton); (4) aluminum (US$ 2,824.23/ton), (5) tin (US$ 28.536/ton), (6) lead (US$ 4,927.81/ton),
(7) zinc (US$ 2,933.26/ton); (8) high rank coal (US$ 239.43/ton)
Precious metals: (1) gold (US$ 3,973.93/troy ounce); (2) platinum (US$ 4,162.35/troy ounce); (3)
silver (US$ 68.01/troy ounce).
Note: The three drivers may add to price increases, and governments’ are expected to increase
legislation and regulation reforms as they push to maximise benefits (e.g., Chile and PNG). That may
cause a supply shortage. Legislative push for downstream processing may not occur soon enough due
to lack of energy and technology requirements in developing countries like PNG. Also reduced
production due to COVID-19 will significantly cause a shortage of supply in highly infected regions in
South America.
 BE AN INFORMED LEGISLATOR AND REGULATOR
THE WORLD IS PREPARING FOR THIS NOW, WHAT ABOUT PNG?
 RESOURCE EXTRACTION POLICY

1. Mineral extraction sustainability policy

- Attract foreign direct investment using a competitive fiscal system
- Mining legislation that is user-friendly and stable
- Mining tenement security over the life of a project
- A transparent bidding system for securing tenements

2. Government and the community

- Monetary and non-monetary benefits

- Maximise tax revenues for social development
- Mineral revenues to sponsor infrastructure developments
- Support the lagging non-minerals sector (e.g., agriculture)
- Economic expansion and manufacturing for economic growth and increase export and GDP
- Community expects spin-off benefits through equitable redistribution mechanisms
- Share costs and benefits with provincial governments
- Higher security of employment and rewards for employees
- Contractors benefit from the extraction activities
- Allow local businesses to flourish and expand
 BENEFICIARIES IN RESOURCE EXTRACTION

3. Social and environmental sustainability

- Extraction activities improve the living standards of the host communities

- Build skills capacity and support sustainable enterprises to emerge

- To ensure tailings and other environmental impacts do not impact people’s lives
now and beyond a mine’s (project’s) life

- Cultural, social and ecological endowments must be protected

- Harmonize the co-existence of mining land use and other life supporting enterprises
to occur concurrently

- Reduce negative impacts and maximise the positive impacts that would exist
beyond a mine’s life
 INDUSTRY’S EXPECTATIONS ON RESOURCE LAWS AND REGULATION

 A licence granted must be secured over an whole of life of a mining project. Legislated or
legally bidding promissory MDC clauses such as “fiscal stability” often protects investor’s
rights. A top priority is that an investor seeks transparent political and social bargaining
processes that clearly determine the national and local contents through fiscal measures
and policies that are aligned within the legislative framework.

 Fiscal stabilisation clauses in MDCs must be balanced. It should avoid investor focus
(fiscal leniency like tax holidays); and national and local content focused (high tax rates,
royalty, production sharing etc.). Investment disputes often arise from alleged breaches of
stabilisation clauses and bilateral and multilateral investment treaties. For instance, the
Porgera’s FA provides fiscal stability insurance by charging a 2% tax on top of the
corporate income tax.
 Bilateral investment and multilateral treaties seek to support financial, capital and labour
imports and export restrictions.
 Now a days, political risks have become a critical priority over fiscal laws. These are: risks
of disrupting an operating mine; currency convertibility and transfer restrictions; returns on
projects; expropriation of operating mines; civil unrest; war and terrorism; and breach of
contract and non-honouring of sovereign financial obligations.
 POLITICAL AND REGULATORY RISKS

 In jurisdictions whose political risks are high and investors are unwilling to invest, international
organizations like the World Bank provides Multilateral Investment Guarantee Agency (MIGA) as
an investment guarantees against political risks and gives assurance to a firm to invest in that
country (specially benefits venerable lower to middle income countries like PNG). Newcrest is
taking approach to seek MIGA from the world Bank to develop the Wafi-Golfu project.

 Likewise, reports of investment attractiveness ranking are often used as indicators of security
assurance and predictability of local laws for investments on foreign soils. The extractive industry
risk survey published in World Risk Report shows that PNG is placed in ‘C’ category, indicating that
it is perceived as a high-risk jurisdiction due to uncertainty over long-term security of mining leases
(Chris, 2020). Also, credit worthiness ratings such as Standard and Poor, Moddy and Fitch Ratings
assist investors to consider their investment and financing decisions that could possibly delay a
financially attractive project.

The political and regulatory risks may outweigh the geological attractiveness and
financial viability (NPV & IRR).
 POLITICAL AND REGULATORY RISKS

 Wafi-Golfu project – a right deposit at the at the right time? -weight it out
The Wafi-Golfu copper-gold project is tipped to coincide with the high copper and gold prices, with
its financial attractiveness (high NPV: $1.8 bln and IRR: 18%) and long mine’s life. The quality and
geological reserve of the deposit are much higher than that of the Ok Tedi copper mine.

However, combined with the recent high-risk rating, change of mining laws (Mining (Amendment)
Act 200), series of litigations by the MPG and landowners opposing the DSTDS, and the quests for
increasing the national and local contents, put a BIG QUESTION is whether the Mining Forum will
eventuate in July 2021. My prediction, is that Newcrest may not want to talk about Wafi until after
the 2022 National Election.

 The government proposes a social loyalty fund against these risks to entice the LOs to attend the
Mining Forum and sign the MoA to grant SML. “The K100 million development fund (PMJM
promises) is in the budget and available but landowners will not get the money if the development
forum is not held.” (Post Courier, June 23, 2021) – A band-aid solution?

 At the development stage of a new project, the major controversy emerges at the investment
negotiation stages relating to national and local contents (fiscal benefit packages and benefit
sharing mechanisms), and social and environmental impacts rather than holistically opposing a
mining project.
COMMUNITY CONCERNS?