Mining and Minerals Division Guidance To Mine Operators for Calculating Reclamation Costs in Net Present Value December 29, 2004

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1 Mining and Minerals Division Guidance To Mine Operators for Calculating Reclamation Costs in Net Present Value December 29, 2004 The Mining and Minerals Division (MMD) provides the following guidance for proposing net present value calculation cost estimates for reclamation costs for mines with approved closeout plans with scheduled completion dates exceeding five years. This guidance document is issued pursuant to C.1 NMAC, which requires MMD to issue guidance on acceptable methods for calculating net present value by December 30, This guidance will be updated periodically not to exceed 5-year intervals. This guidance document is not a rule adopted pursuant to the New Mexico Mining Act; it is intended to provide assistance to mine operators and the public. Background The New Mexico Mining Commission amended certain portions of its financial assurance rule, NMAC, effective December 30, Some of the changes to the Part 12 of the Mining Act Rules include the following amendment to C: The director may accept a net present value calculation for the amount of financial assurance required pursuant to Subsections A and B of NMAC, if the scheduled date for the reclamation or closeout plan exceeds five years following closure, not including the 12 year period described in Subsection A of NMAC for re-establishing vegetation, and if the financial assurance will be provided in the form of cash or other allowable form of financial assurance to be converted into cash upon forfeiture. The director shall require an appropriate adjustment be made to the net present value calculation to exclude anticipated delays for converting financial assurance into cash. Subsections (1) and (2) of C specifically provide as follows: (1) The net present value calculation shall be based upon projected inflation rates and projected rates of return over the term of the reclamation plan and shall be based upon publicly available indices and data. The director shall determine whether a proposed net present value calculation is acceptable and complies with the requirements of Subsection B of NMAC. The director shall issue guidance on acceptable methods for calculating net present value within one year from the effective date of this rule. (2) The director shall review any approved net present value calculation as needed, but at least once every five years, to take into consideration additional information regarding rates of return and inflation rates.

2 2 Purpose of Determining the Net Present Value of Reclamation Costs The net present value (NPV) calculation allows a mine operator who has an approved reclamation plan taking more than five years to complete, to reflect the time value of money in proposing the amount of financial assurance that needs to be posted in connection with a reclamation plan. In the event a default occurs either because an operator is unable to complete the reclamation plan, the terms of the permit are not met, or a default in the conditions under which the financial assurance was accepted occurs, the State of New Mexico would forfeit the financial assurance pledged by the operator for the mine site in order to complete the reclamation plan. Financial assurance amounts would be deposited into one or more investment accounts established by MMD, pending its expenditure for reclamation costs. MMD would invest the amounts not immediately needed for reclamation. At this time, MMD contemplates that the investment portfolio may include fixed income investments such as, investment grade bonds, U.S. Treasury obligations, state issued securities, time deposits and other similar instruments. Operators may assume a conservative rate of return over time on investments, but must also project an escalation rate that reflects that the cost of completing the reclamation work will also increase over time. Both the projected rate of return and the projected escalation rate must be taken into account when determining the net or present amount of financial assurance necessary to be pledged today by the operator to cover future reclamation costs. Procedure for Calculating the Net Present Value of Reclamation Costs For A Mine There are at least two components necessary in applying an NPV calculation, the escalation rate and the discount rate. Escalation Rate: The inflation rate or escalation rate is used to estimate the expected effect or rate of inflation on reclamation costs over time. Discount rate: The discount rate is used to estimate the expected rate of return to be earned from the investment of cash or cash proceeds over time, pending expenditure for reclamation. If a mine is eligible for an NPV calculation to be applied to its financial assurance obligation, an operator should notify MMD of its intentions to apply an NPV to its approved cost estimate. If the financial assurance will be in the form of a joint instrument with the New Mexico Environment Department (NMED) the NMED should be notified as well. MMD will either provide the appropriate discount rate that should be applied to the approved cost estimate or request that the mine operator propose a discount rate as provided in this guidance. In establishing a discount rate, MMD will consider historical and current rates of

3 3 return. Financial experts may also be consulted. NMED must concur with the discount rate, if the operator is proposing a joint financial assurance instrument with the NMED. The operator may propose an escalation rate that is appropriate for the reclamation work to be performed at their mine site by utilizing the following steps: Step 1) Use the most recently MMD approved cost estimate for reclamation which includes, at a minimum, contract administration, mobilization, demolition, engineering, redesign, profit and overhead, procurement costs, reclamation or closeout plan management, and contingencies normally available to a third party contractor. This estimate should be in current dollars. Step 2) Apply an appropriate escalation rate, or rates, to the cost estimate by using publicly available indices. Acceptable indices include certain indices maintained by the U.S. Department of Labor, Bureau of Labor Statistics. The Consumer Price Index for all Urban Consumers (CPI_U), Construction Cost Index, Building Cost Index, are examples of indices that may be suitable depending on specific reclamation work required. If another index is proposed, a detailed justification for using that index should be provided. The indices used should be appropriate for and specifically related to the costs associated with the reclamation plan. The projected escalation rate should be based on historical inflation rates over an appropriate timeframe. A composite index may be proposed. Step 3) Provide a full explanation of why a particular index was chosen and also explain how the rates were calculated that go into the formula below. Clearly identify the historical timeframe used in creating the escalation rate proposed, and justify the use of that timeframe. Be sure to reflect the reclamation schedule in applying the escalation rate to the reclamation costs. If more than one escalation rate is proposed, also explain the reason(s) for doing so. The formula for applying the escalation rate is: P x (1+i) n =F P=current cost i=inflation rate n=number of years Step 4) If MMD requests that the operator provide a discount rate, apply a discount rate, or rates, to the cost estimate using publicly available indices or historical rate of return charts. Acceptable indices include certain Lehman Brothers fixed income indices such as U.S. Aggregate and U.S. Government. You must utilize the same historical timeframe used to

4 4 identify the escalation rate. For short-term expenditures, that is, years 1-10 of reclamation work, identify an index that measures the rate of return on U.S. Government obligations; the preferred index is Lehman Brothers U.S. Government. For years , which may include long-term water treatment, identify an index that would measure a total bond return; such as Lehman Brothers U.S. Aggregate. Step 5) Provide a full explanation why you chose a particular index or rate of return chart in developing the discount rate or rates. Clearly identify the historical timeframe used in creating the discount rate proposed, and justify the use of that timeframe. If more than one discount rate is proposed, also explain the reason(s) for doing so. Sept 6) In addition to, or as part of the margin required pursuant to C(1)(a) NMAC, you must include a proposal for adjusting the NPV calculation, or explain why no adjustment is necessary, to reflect any foreseeable delay in liquidating the form of financial assurance into cash in order that the NPV calculation will be based upon the time value of money, not the value of the financial assurance before it is converted into cash. The Director shall review the proposal and determine whether or not it is appropriate. Step 7) MMD shall evaluate the proposals and may accept, reject or modify the proposal. In addition to evaluating the appropriateness of either the proposed escalation and discount, MMD shall also evaluate the appropriateness of the real discount rate, that is the difference between the discount rate and escalation rate. The formula for applying the discount rate is: F x 1/(1+D) n = NPV D=discount rate NPV=net present value N=number of years To illustrate how an NPV calculation would be applied to a cost estimate, we have included the attached example: Reclamation cost estimates and NPV calculations will be reviewed periodically, not exceeding five-year intervals.

5 Any Mines Company Cash Flow and NPV Table - Example 10 Year Summary: Total Inflation Rate = 3.2% 15 year 2003 to 1989 CPI 2003 Cost $ 10,000,000 Discount Rate = 5.0% Inflated $ 11,570,033 Mine Closure Today NPV $ 9,262,800 Year Current Cost (P) Inflation Rate (%) (i) Future Amount (F) Discount Rate (D) Net Present Value (NPV) 0 $1,000, % $1,000, % $1,000,000 1 $1,000, % $1,032, % $982,857 2 $1,000, % $1,065, % $966,008 3 $1,000, % $1,099, % $949,448 4 $1,000, % $1,134, % $933,172 5 $1,000, % $1,170, % $917,175 6 $1,000, % $1,208, % $901,452 7 $1,000, % $1,246, % $885,998 8 $1,000, % $1,286, % $870,810 9 $1,000, % $1,327, % $855,881 Totals $10,000,000 $11,570,033 $9,262,800 P x (1+i) n =F P=current cost i=inflation rate n=number of years F x 1/(1+D) n = NPV D=discount rate NPV=net present value N=number of years