Mining project finance and the assessment of ore reserves
Authors: O’Leary J. 
Published: April 2008

The estimation of ore reserves is one of the most critical activities in the mining investments decision process. All other activities will depend eventually on how well grades and the associated tonnages are computed. Unreliable estimates will affect the financial viability of a project and while errors may not be ‘life threatening’ to high profit margin projects errors on the scale commonly encountered can do irreparable damage to a low margin business. In response to this, numerous classification systems have been devised, the purpose of which is to impart from the technical decision makers to the financial decision makers (in industry or the financial community) the confidence that may be had from a reserve estimate.

Project finance is a difficult and misunderstood mechanism for providing finance to major infrastructure projects. This is particularly true for the mining industry where project finance is common. By definition, project finance is that form of finance that the sponsor (typically a mining company) has segregated from the general assets and corporate obligations of that company. The project borrowings will be securitized, typically by the project assets and repayments will be derived from the project cash flows. That is to say there is little or no recourse to the borrower should the project fail. This form of finance can be attractive for the banks in that interest margins can be three to four times higher than for corporate borrowing, but attendant with their reward is the assumption by the banks of considerable risk.

As repayment will be derived from project cash flow the major risks being assumed are that project revenues will not be up to that forecast or that project cost will be in excess of that forecast or both and that the cash flow is insufficient to meet the interest and principal repayments. Whereas there is considerable experience in forecasting costs, revenue is more problematical in that it is dependent mainly on the commodity price and the estimate of quantity of the metal produced. The commodity price has its own special problems that are beyond the scope of this paper. The quantity of metal is directly related to the forecast of mineable tonnes and grade i.e. the statement in any one period of the mineable reserve.

The confidence of a reserve estimate is thus of direct interest to a bank involved in a mining project finance. Traditionally the confidence was supplied through a classification system and the terms ‘proved’, ‘probable’ and ‘possible’ and their equivalents are a means of expressing the uncertainty (geological and other) associated with a reserve estimate. There has been, however, much criticism of these traditional statements of confidence and many of the criticisms of the traditional classification schemes centre around the subjective nature of the definitions of assurance and their misuse and abuse. Recently the need for quantitative definitions has arisen in view of the trend to mining low-grade deposits where a high degree of confidence in a reserve estimate is vital. Many argue that because a quantitative approach can be taken then it should. With the development of geostatistical theory starting in 1966, estimation techniques have evolved where the expected error of the estimate can be calculated as an integral part of the estimation procedure. There is therefore the possibility of not so much modifying the current classifications but developing a new scheme aimed at the financial community where the levels of confidence are related both to the estimation error and to the time period for which the estimation is related.