Understanding price fluctuations and implementing best practice in Reserve estimation
Volatile commodity prices present particular challenges for Competent Persons and companies and their obligations to keep the market informed.
One of the hot-topics from the recent Monograph 30 Roadshows was the influence of recent swings in commodity price. In extreme cases people asked ‘does the Ore Reserve estimate still exist?’ and we heard a paper from Michael Creech where he presented a study of mine closures that had on average 20-30 years production in their Ore Reserves prior to closure (Creech, 2014).
For the Competent Person this issue can place you front and centre to the Chief Executive Officer (CEO) and you need to be able to explain thousands of hours of technical work clearly and concisely to either reassure or prompt the decision to publish a re-estimation (a new ‘Public Report’). As part of the annual process of renewing consent each year in annual reports, the Competent Person may also need to have a difficult conversation on the validity of the Ore Reserve.
For the CEO it’s important to understand that a re-estimation of the Ore Reserve with a different price can take some time. If appropriate sensitivity testing is done at the study level and in each revision of the Ore Reserve, then the CEO and the market can be informed of the valid ranges and when a new Ore Reserve estimate is required.
Due to fluctuations in commodity prices over the last year and some mine closures when companies have still been reporting an Ore Reserve, frequently asked questions have arisen:
- As a Competent Person, how can I be confident of the price I am using?
- When does a change in price trigger a new Ore Reserve?
- What does the CEO and the market need to know?
- How does the Competent Person defend the Ore Reserve when prices change?
- What are some good practices around price estimation and sensitivity to test materiality?
- What happens to an operating mine when the price varies materially from the long term forecast?
Price is required to be discussed in JORC Table 1, Section 4 – Estimation and Reporting of Ore Reserves under the Criteria ‘Revenue factor’ and ‘Market assessment’. It is one of a number of non-resource modifying factors and can be difficult to predict.
The Competent Person needs to be satisfied with the price supplied. If the long-term real price is significantly above the spot then it may be time to ask for some more information. Ideally companies should have an official process; an example could be a Resource and Reserve Committee that involve the price forecasting team. Good practices in obtaining price data include:
- obtain a current long-term real price from an independent commodity forecasting organisation
- obtain a current long-term real price from the finance department; be sure to ask clearly for the long-term real price and currency
- benchmark and perform statistics on the price against consensus forecasts, understand the ranges and historical trends
- along with other modifying factors, have the person who supplied the number complete a consent form, noting their qualifications, role, that they are responsible for the factor and the source of documentation – it helps them understand and support the process
- ensure the CEO and other key business leaders sign-off on the modifying factors being used; during this process it’s helpful to outline the timeline, process and sensitivity – this step will minimise late revision requests and re-work.
Communicating the sensitivity
It is important to know how sensitive the operation is to fluctuations in long-term price, this way the Competent Person can communicate the price changes to the organisation. If the price change is likely to be material the Competent Person should mention this in Table 1, Section 4 appendices to Public Report. The Competent Person could mention the sensitivity work done and where the trigger is, for example: ‘The sensitivity analysis of the Ore Reserves tonnage to price fluctuations shows reasonable stability of tonnage out to a reduction in price of 30 per cent from the long-term real forecast’. Price changes in spot commonly do not have any bearing because of the use of long-term price forecasts, but not everyone is aware of this. It is important for the Competent Person to have the sensitivity work ready to answer questions on this topic.
Good practice to communicate the sensitivity includes:
- a sensitivity analysis should be done on an appropriate range
- include sensitivity results in Public Reports
- note the sensitivity results in Table 1 Section 4 ‘if not, why not’ appendices to Public Report
- note the material price ranges on the company risk register
- regularly review the long term price forecasts along with all modifying factors
- communicate that fluctuations of 5-6 per cent are normal and minimise inclusion of material that cannot stand the test of time
- assess early and warn the CEO well ahead of time if a downgrade is coming and have a write down review process.
The CEO and the market are likely to want the following questions answered (in a couple of pages with graphs and tables):
- What assumptions were used? (Note the sign-off obtained at the start of the process).
- For a range of prices where is the operation net present value (NPV) positive?
- At what price are the operation’s cash margins zero?
- What are the impacts on the Ore Reserve estimate tonnages for the price ranges?
- Is there any upside from an increase in price?
- At what price (higher and lower) should we consider going back and changing the mine design?
- What are the opportunities to refine the cut-off grades or specifications?
Sensitivity to price changes can be done at the study stage, Ore Reserve estimation and also in the company financial models. All are important and the methods vary for underground and open pit operations.
- Study stage: at the study stage the sensitivity is more strategic. A range of factors can illustrate the economic options for size, production rate and cut-off grade and identify material drivers.
- Ore Reserve estimation: a mining method exists and price sensitivity may trigger modifications, reductions or increases in areas of the operations, production rates and/or cut-off grades. This can be used to illustrate and communicate materiality.
- Company-wide financial models: the mining method, production rates and cut-off grades are usually fixed so it is just the non-resource modifying factors that can be evaluated. The benefit is this is usually a complete model with all factors and stakeholders involved. During Ore Reserves estimation it is essential the Competent Person sees this model, inspects factors used and understands the sensitivity done. It is this sensitivity result that should be noted in Public Reports.
Open pit and underground sensitivity
When designing an open pit, a common process, called pit optimisation, is run to pick a pit shell from a set of nested shells. One of the shells will have the desired profit point for the organisation. Part of pit optimisation is also to run sensitivity on a number of modifying factors, such as price, cost and slope angles. Once the pit shell is picked, final design is created from this shell and a schedule created.
Good practice in open pit sensitivity includes:
- involving key stakeholders in pit shell selection and sensitivity results, including finance
- for material changes in price, a full pit-optimisation process, design and schedule will be required
- non-material changes in price can be managed through the financial model and sensitivity will increase or decrease the operation’s NPV
- the Competent Person could identify areas which could be placed on hold for lower prices or brought in for higher prices; the areas may be complete pits, staged pushbacks or a change of pit depth.
In underground mining the cut-off grade is the primary decision. A number of different sized orebodies can be designed at various cut-off grades. There are often a number of cut-off grades in a mine:
eg for development and for stoping activities.
Good practice in underground sensitivity includes:
- Defining the various cut-off grades: picking the break-even cut-off grade gives a break-even result, so good practice is to ensure the operation’s NPV target is included.
- Create a sensitivity matrix of prices and costs: software exits that can quickly create stope shape scenarios which can be assessed for feasibility; compiled in a matrix with cut-off, production rates and resulting NPV, some sensitivity to price can be illustrated.
- Estimating correct operating and capital costs: this can be a large challenge especially for overseas underground operations.
- The Competent Person could identify production stope areas which could be placed on hold for lower prices or brought in for higher prices. This may mean mining is limited to areas that already have access and are close to extraction points. Deeper development may be put on hold. It is important to understand the impacts of selective mining in these cases to minimise loss of future Ore Reserve (sterilisation).
- Examples of fluctuations in commodity price
Figures 1 to 3 illustrate price fluctuations for gold, thermal coal and iron ore. It is important to understand what the past fluctuations have been, the spot price and long-term real price forecasts. A sensitivity analysis should be done on a range that is large enough to reflect the annualised volatility rate across a number of market cycles. For example, there is limited use in presenting a sensitivity range of ±10 per cent when the real metal price can move ±30 per cent in one year.
Summary answers to price questions
As a Competent Person, how can I be confident of the price I am using?
The price is often supplied by finance. Ensure you have asked for an appropriate price and the units (usually a long-term real forecast price). Sometimes the price can be sourced from an independent forecasting organisation. Examine the prices, check against historical trends, ranges and the consensus forecasts. Ensure key stakeholders agree on the price being used to avoid late revision
When does a change in real long-term price trigger a new Ore Reserve?
The Competent Person should be aware of the sensitivity of all Modifying Factors used in estimation of an Ore Reserve. This can be done in study stage, pit or stope optimisation work and through company financial model sensitivity. Good practice would be to note where the long-term price may trigger a revision of the mine design on a company risk register and to regularly review factors. Sensitivity and communication of the sensitivity is essential to be able to answer questions and inform investors in Public Reports, especially if the spot price is lower than the real long-term forecast.
How does the Competent Person defend the Ore Reserve when prices change?
Table 1, Section 4 – In Revenue and Market assessment the Competent Person can mention source of forecasts, sensitivity work done and the range of real long-term prices the Ore Reserve estimate is valid for. It is important to refer to the long-term real price forecasts and not react to daily changes.
What are some good practices to test sensitivity to price?
At the mine design stage, options for size, production and cut-off can be sensitivity tested for various factors, including price. This can communicate sensitivities for price and when changes to the mine design may be required. Ore Reserves estimation methods will involve sensitivity on open pit shell choice and underground stope size optimisation. During the Ore Reserves process it is essential the Competent Person reviews the company financial model to examine values used and sensitivity performed on that model.
What happens to an operating mine when the price decreases materially from the long-term forecast?
This is a business decision. Depending on the company’s position they may continue to operate, place on care and maintenance or close the operation. As a Competent Person it is important that you have communicated the sensitivity of the Ore Reserve estimate to price and that you have provided options to communicate areas that may assist the operation. Annual consent provides an opportunity for a revision, but communication using the sensitivity can help the Competent Person and CEO in their decisions and to keep the market informed.
The AusIMM’s Mineral Resource and Ore Reserve Estimation (Monograph 30), has some relevant articles on this topic, they are:
Watkins, R P, 2014. The influence of revenue and cost factors on ore reserve estimation, Mineral Resource and Ore Reserve Estimation, The AusIMM Guide to Good Practice, second edition, pp 479–486 (The Australasian Institute of Mining and Metallurgy: Melbourne).
Creech, M, 2014. Reserves, reserves and not a tonne to mine – a study of reserves reported prior to mine closure, Mineral Resource and Ore Reserve Estimation,
The AusIMM Guide to Good Practice, second edition, pp 627–634 (The Australasian Institute of Mining and Metallurgy: Melbourne).