Financial Modeling of Mining Projects: A Tool for Optimizing the Financial Benefits of the Mining Sector
The financial model of a project is one of the most important documents a mining company will submit as part of a package of documents to get a mining license in most mineral-rich countries. However, this valuable tool seems to be underused by developing country administrations in their interaction with mining companies throughout the life cycle of mines.
What is a Financial Model of a Mining Project?
Every industrial mining project has a financial model that is generally submitted (along with the feasibility study) to the mining administration of the host state during the permitting process.
The financial model is an Excel spreadsheet transcribing the main economic data of the project, including such indicators as the prices of minerals, Opex, Capex, cost of capital and income data. The model also highlights, through mathematical formulas, the key indicators for investment decisions: net present value (NPV), internal rate of return (IRR) and weighted average cost of capital (WACC). Obviously, these data points are based on projections and are not definitive.
How Can a Financial Model Become a Fundamental Tool for the Mining Company and the Host State?
For a mining company, this document is essential to analyze the profitability of its project and decision to invest. Thus, it is unlikely an investor will embark on a project when its financial model has a negative NPV or an IRR below the financing cost (WACC), regardless of the likely scenarios considered.
For the host state, the financial model is a fundamental tool for assessing the economic viability of a mining project before the operating permit is granted, though the impact of this tool and the benefits a government can draw from it are much greater.
How Can Mining and Fiscal Administrations of Host States Benefit from Mining Project Financial Models?
The potential benefits of financial models reach far beyond analyzing the profitability of mining projects to assist with the decision of whether or not to grant a mining license.
First, a financial model is a precious tool for contract negotiations with mining companies, helping to simulate the financial impact of any proposal of a party on the economic viability of the mining project. For example, both parties will be able to assess whether the project remains profitable without a tax holiday or to what extent granting such a tax holiday affects the sharing of mineral resource rent between them.
Secondly, a financial model can serve as a dynamic dashboard in monitoring a mining company’s activities. It allows the administration to compare initial projections with current project data to better manage operations or make appropriate adjustments in consultation with mining companies. It can also be a valuable tool in the fight against tax avoidance.
Finally, a financial model can also be useful during the revision process of the national mining regulations, providing valuable information on the financial impacts of various legal changes envisioned by a country on operating (or planned) mines in the territory.
All these elements are critical for optimizing financial benefits from the mining sector for mineral-rich countries.
What are the Challenges of Filing Financial Models as PDFs?
An important issue is developing countries’ ability to work with the information contained in the financial models.
Generally, the financial model is submitted to a host state as a PDF file rather than an Excel table. In this format, officials cannot (1) test the reliability of the financial model, (2) verify its underlying hypothesis, such as commodity prices or production costs, and (3) perform sensitivity analyses by varying the hypothesis and interpreting the results on key indicators of the project, in particular NPV and IRR.
For example, what would be the impact on project profitability in year n + 4 in case of a 30 per cent drop in commodity prices, a 20 per cent increase in production costs, or a 2 per cent increase in the royalty rate? What about if you grant a tax holiday the first five years of production or conclude a signing bonus of USD 10 million?
As a result, in PDF format, a financial model is of little use for the administration of the host state. It remains possible to rebuild the model as an Excel table, but this requires specific expertise, and is costly for most developing countries.
A solution could be to require mining companies to file their financial model under an Excel table format. However, this option should be carefully designed in order to address legal and confidentiality implications for the sensitive commercial data contained within the document.
How is IGF Helping to Strengthen Capacity of National Administrations to Leverage Financial Modeling for Mining Projects?
Another issue related to financial models is the low technical capacity in many member states of the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF) to analyze these tools, to test their reliability and use them in monitoring mining company’s activities. While there is no expectation for every official to become an expert in financial modeling, it’s important that those in charge of mining have sufficient knowledge in order to be able to use a financial model and interpret the results.
Adequate use of these tools could help reduce asymmetries between the government and mining companies, and could ultimately help ensure a fair sharing of mineral resource rent throughout the life cycle of a mine.
As part of its capacity building program, the IGF, on request from members states, can provides capacity-building workshops on mining project financial modeling.
For example, UEMOA member state ministries in charge of mining, and economy and finance had the opportunity to discuss the importance of financial models and their potential uses by national administrations during a workshop help July 3-7, 2017, in Bamako, Mali. Participants explored challenges in accessing, analyzing and using financial models for mining projects, and how these models can benefit their region. This workshop was jointly organized by UEMOA Commission and the IGF.
We invite you to read the French version online here.