Are current exploration programs effective in maintaining adequate mineral reserves? Speakers debate the question at the record-breaking 2010 PDAC convention.
By Russell A. Carter, Managing Editor
Following a year in which mineral exploration budgets plummeted, mostly from financial strain in the junior company sector, attendance at the 2010 Prospectors & Developers Association of Canada (PDAC) convention and trade show exhibited few signs of waning interest in exploration issues. According to PDAC, total attendance at this year’s annual event was a record 21,660, surpassing the 2008 convention’s 20,168 attendees, with roughly 1,000 companies participating in either the trade show or investors exchange.
The show’s robust attendance figures highlighted an optimistic mood pervading the industry—not the giddy attitude of the boom days preceding the 2008 bust, but more a sense of relief from unfulfilled expectations that the industry was facing a long, difficult and uncertain recovery. Those fears mostly vaporized as 2009 progressed: by March, commodity prices had noticeably strengthened, driven by Chinese demand, and precious metals rebounded. From late 2008 to late 2009, for example, gold was up more than 25%, silver more than 57% and platinum almost 63%.
To be sure, 2009 wasn’t a banner year for exploration. Metals Economics Group, a Halifax, Nova Scotia-based firm which tracks exploration statistics worldwide, reported planned nonferrous exploration budgets of the 1,846 companies participating in its annual survey on corporate exploration strategies totaled $7.32 billion for 2009—down from a record $12.6 billion in 2008, marking the largest one-year decline in the past two decades. However, despite the deep cuts to exploration plans, the industry’s 2009 nonferrous exploration budget total remained well above levels seen prior to 2006, according to MEG. Junior-company exploration spending fell by more than half in 2009 compared with the previous year, followed to a lesser degree by intermediate producers—the result being that exploration budgets among the major producers stood atop the heap for the first time since being overshadowed by juniors in 2004.
The financial blow dealt by the global economic downturn caused widespread damage among the juniors, dropping market capitalization for both the TSX-V mining sector and the entire TSX-V by more than half from 2008 levels. However, MEG attributed the drop in junior-company exploration spending to a sector-wide cutback by companies just trying to survive the slump, citing its data which indicate the number of juniors actively exploring fell by only 6% from 2008 to 2009.
A February 25, 2010, report issued by PriceWaterhouseCoopers Canada detailed the losses incurred by junior companies following the economic slump. “In the 12 months ending June 30, 2009, the global financial crisis eroded the share prices of most junior mining companies and made it nearly impossible for many of them to raise money to finance their projects,” wrote Paul Murphy, partner and mining industry leader for PwC. “While some investors were prepared to take a chance on production and development companies, exploration companies, or any company perceived to carry a higher investment risk, were left out in the cold.”
As the top 100 TSX-V companies tried to conserve cash, exploration spending declined. The top 100 group wrote down a total of $644 million on mineral properties and exploration as projects were either abandoned or put on hold. Stock-based compensation fell in tandem with share prices and was 30% lower than the prior year.
Smaller mining companies merged in order to survive, resulting in a 129% increase in acquisitions by exploration companies in the top 100 in 2009.
The PwC report pointed out that cash available to the junior mining sector dried up in 2008 and financing became even more challenging for the top 100 in the first half of 2009. For the year ended June 30, cash provided by financing activities (both debt and equity) dropped 21% to $1.5 billion. Expenses also declined as companies sought ways to economize.
Of the top 100 companies in 2008, the PwC report stated that only 48 remained in the 2009 top 100 list. Most of the remainder dropped off the list as their market capitalizations fell, while eight—five of them gold companies—graduated to the TSX and another seven were acquired. The 100th company on the 2009 list had a market capitalization of $25.7 million in 2009, compared with $72 million in 2008, reflecting the serious deterioration in market conditions for the junior mining sector.
The struggle to survive led to a spike in the number of mining M&A deals involving junior companies in 2009. On March 1, PwC issued a press release noting “the number of small deals (below US$250 million) was significantly above the prior three years, with a total of 1,859 deals. This trend was driven by consolidation of smaller players and deals driven out of necessity for survival rather than opportunistic or strategic growth ambitions.”
Questioning Exploration Efficiency
The sudden shrinkage of industry exploration budgets renewed debate over some broad, ongoing issues: Are companies—and investors—getting the best bang for a buck out of their exploration programs? Overall, how good of a job is the industry doing in finding new deposits and replenishing reserves? How can exploration performance, and success, be improved?
Two speakers at a PDAC session that addressed the question “Exploration Expenditures are increasing, but discoveries are not. Why?” expressed widely divergent opinions. Michael Doggett, president and COO of HanOcci Mining Advisors, citing copper exploration and production data compiled from 1979 through 2008, began by positing: “The purpose of exploration is to replace reserves. If we’re talking about the copper business, a simple measure of exploration effectiveness then is simply the replacement ratio of reserves to production.”
During the period 1979–2008, continued Doggett, copper reserves in 1979 were 350 million metric tons (mt); in the following 30 years the industry produced 322 million mt, and at the end of the period reserves were reported as 550 million mt. Exploration during that span resulted in a net addition of 522 million mt of copper.
To determine the reserve replacement ratio, he explained, divide net reserve additions by production:
• For 1979-2008 = 522/322 = 1.6
• Similarly, the reserve replacement ratio for
• 20 years (1989-2008) = 1.9
• 10 years (1999-2008) = 2.0
“We have consistently added reserves at a rate far exceeding overall production. Does this look like an industry with a discovery problem?” said Doggett.
Continuing in the same vein, he said another simple measure of exploration effectiveness is the ratio of reserves to production for any given year. This metric represents the number of years of output supported by the current year’s reserves, assuming no growth in annual output or reserves. If this metric does not decline over time, then exploration is effective in both replacing reserves and sustaining growth trends.
“In spite of doubling annual production during the past 30 years, we have been able to maintain a base of more than 30 years of production at current rates moving forward. Does this look like an industry with a discovery problem?” Doggett said.
“As an industry we have been highly effective in replacing reserves through exploration, but this measure does not say anything about what it costs to be highly effective. To do that we need to factor in the amount of money spent on exploration,” he said.
During 1979–2008, the global copper industry spent approximately $22.5 billion on exploration; over the past 20 years, it spent $17.7 billion, and over the past 10 years, $10.3 billion.
“We can measure exploration efficiency by considering how much it cost to add reserves over time,” he said. “Consider an efficiency of exploration metric whereby z = net reserve additions, a = cost of making additions (exploration expenditure), with a/z = cost per unit of adding reserves. Thus, the cost of adding a unit of copper reserves from 1979-2008 was: $22,540 M / 522 million mt = $43.20/mt ($0.02/lb).”
This calculation shows that over 30 years ($0.020), 20 years ($0.016) and 10 years ($0.016) the industry, in terms of efficiency, has generally been able to consistently add copper to reserves for two cents or less per pound of copper—another indication of exploration efficiency. In addition, Doggett said the copper industry has consistently spent 2%–4% of sales revenue on exploration, in contrast to the gold sector, which at times spent more than 12% of sales revenue on exploration during the same period.
As for the probability that this efficiency can be sustained in the future, he suggested that in recent years exploration effectiveness and efficiency have been driven by brownfield additions to reserves in conjunction with major expansions at the world’s largest copper mines. For much of the next decade, this will continue to be the case. Beyond 2020, however, the ability to increase reserves and annual output at known mines is at best uncertain. The underlying resource base is large but much of these resources are challenged by political, economic, social and technological issues.
Long lead times to find and develop new mines (on average 20 or more years) restricts the conversion of resources to proven and probable reserves. To meet anticipated demand for new primary supply of copper, the industry can only bank on brownfield success for so long. New discoveries are essential. Exploration effectiveness and efficiency will necessarily decrease when this crossover point is reached.
“Can the industry do better [in exploration]?” Doggett questioned. “In the face of the cumulative impact of billions of dollars of exploration expenditures in the past few decades, it is completely unrealistic to think that we will magically get better at exploration.” There’s no silver bullet or panacea on the horizon, he suggested, but to date, advances in technology and the cumulative base of knowledge gained from past exploration have been dependable factors in keeping up with the relentless forces of depletion.
Gold: Searching for Reserves
Stephen Enders, director and principal consultant at Renaissance Resource Partners, Denver, Colorado, USA, and former senior vice president of worldwide exploration at Newmont Mining Corp., presented a less sanguine view of exploration performance and expectations—at least from the gold sector’s point of view.
From a corporate perspective, he stated, there’s never enough exploration success. “It’s never in the right geopolitical area, and if it is there is something wrong from a social perspective. It’s never enough grade; it’s never big enough. It’s typically not close enough to infrastructure, and if it is then it’s too close.”
There’s also a major disconnect in what major producers want—in terms of exploration success—and what junior companies can accomplish, he stated, suggesting that majors are exploration-phobic and much prefer to acquire discoveries without having to spend the time and resources to conduct their own exploration effort. Juniors, on the other hand, mainly function on an extremely short-term financing timeline. He estimated that only about 30% of juniors are seriously interested in creating wealth for others—“the rest are focused on creating wealth from others.” And, perhaps 50% or more of junior funding “never goes into the ground. They spend it just keeping their lights on,” Enders said.
He said the gold business is quite different from copper—the median gold deposit size is about 350,000 ounces, much smaller than typical copper discoveries and much quicker to deplete. Because of the difficulty of replacing reserves to maintain production, he believes that “from a major’s perspective, [gold] is not a sustainable business” by itself and that’s why major gold producers are now focusing on finding porphyry copper-gold deposits.
Discovery Rate Declines
In the same session, Richard Schodde, managing director of MinEx Consulting, Melbourne, Australia, presented results of a study on global discovery trends from 1950–2009, focusing on how many deposits were found, what commodities were involved, where were they found and who discovered them. The study included nonferrous metals, precious metals, diamonds, and uranium but excluded bulk minerals (coal, iron ore, bauxite) and industrial minerals such as potash, talc or phosphate. It also ignored discovery of satellite deposits feeding into an existing mill within an established mining camp (for example, it counted the Ekati diamond discovery as one world-class discovery, not 20 small discoveries), and limited analysis to major deposits ( > 1 million mt Cu equivalent, > 100 kt Ni, > 1 million oz Au, > 10 million carats, > 25 kt U3O8, etc.). It also assessed quality of the discoveries (Tier 1, Tier 2).
The study’s findings, in a nutshell:
• In spite of record exploration expenditures, the rate of discovery has declined over the last decade.
° Industry is now finding less than 10–20 major deposits per year.
° Only one to two of these are “worldclass.”
° The gold industry is struggling to replace the ounces it mines.
• In the last 20 years there has been a steady shift away from the established countries.
° In the 1980s, Canada, the U.S. and Australia accounted for over half of all major discoveries. Now it is less than 20%.
• Since 1980, the “main game in town” has been gold.
° Currently 60%–80% of all major discoveries are gold-related.
° The current hot spots for gold are Colombia/Ecuador, West Africa and Central Africa.
° The size and grade of the discoveries (for gold) is declining.
° Few major lead-zinc, diamond or uranium deposits have been found in the last decade.
• Since the 1990s, juniors have played a significant role in discovery.
° Currently over half of all major discoveries in the Western World are made by junior companies and small producers.