FINANCIAL INSTITUTIONS ENERGY INFRASTRUCTURE, MINING AND COMMODITIES TRANSPORT TECHNOLOGY AND INNOVATION PHARMACEUTICALS AND LIFE SCIENCES Part 1 Feasibility An essential guide to feasibility planning and construction procurement for junior mining
Part 1 Feasibility An essential guide to feasibility planning and construction procurement for junior mining A NORTON ROSE LLP GUIDE August 2011
Part 1 Feasibility Norton Rose Group Norton Rose Group is a leading international legal practice. With more than 2600 lawyers, we offer a full business law service to many of the world s pre-eminent financial institutions and corporations from offices in Europe, Asia Pacific, Canada, Africa and the Middle East. We are strong in financial institutions; energy; infrastructure, mining and commodities; transport; technology and innovation; and pharmaceuticals and life sciences. Norton Rose Group comprises Norton Rose LLP, Norton Rose Australia, Norton Rose OR LLP, Norton Rose South Africa (incorporated as Deneys Reitz Inc.), and their respective affiliates. nortonrose.com The purpose of this publication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Norton Rose LLP on the points of law discussed. No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any constituent part of Norton Rose Group (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this publication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of, as the case may be, Norton Rose LLP or Norton Rose Australia or Norton Rose OR LLP or Norton Rose South Africa (incorporated as Deneys Reitz Inc) or of one of their respective affiliates. Norton Rose LLP NR11048 08/11 (UK) Extracts may be copied provided their source is acknowledged.
Contents Contents 04 Summary 05 Introduction 07 Feasibility 14 Feasibility stage key point summary 16 Contacts
Part 1 Feasibility Summary The importance of a robust strategy for the procurement of a mining project, from project inception through to construction implementation, can not be underestimated. Full consideration of the key procurement issues identified in this guide can often mean the difference between achieving a bankable project with optimal returns for the mining company, and an expensive project failure. 04 Norton Rose LLP August 2011
Introduction Introduction General By failing to prepare, you are preparing to fail. Benjamin Franklin For junior mining companies in particular, cash is king, but in the race to obtain project finance, we all too regularly see the key iterative steps and considerations mapped out in this guide either being forsaken or missed. The impact of this for the mining company can be considerable. Whilst this guide is primarily written from a western perspective, the increasing significance of Chinese debt solutions in this sector should also be taken into account. This guide will therefore, as appropriate, also offer some insight into the contrasting issues to be considered in the procurement of mining projects in the context of a Chinese debt solution. The need for a strategy This is the first of a two part guide. The aim of this first part is to explore the key steps in pre-construction planning and evaluation (usually referred to as feasibility), and to look at the common misconceptions as to what project sponsors (the Sponsors) should be looking to achieve at this stage. Importantly, we will look at the iterative steps typically required to achieve completion of the feasibility stage of a mining project and the common pitfalls that must be avoided along the way. When done properly, the Sponsors are more likely to be in a position to establish at an early stage, with a degree of certainty, whether or not the economics and general viability of the project stack up. If they don t, the project can be abandoned at the earliest possible point, hopefully before significant amounts of money have been expended. On the assumption that it is established during the feasibility stage that the economics and general viability of the project do stack up, the second part of our guide will go on to look at the detailed engineering and construction phase, and the key considerations that should be made by the mining company to achieve both a bankable and an economically viable project. Norton Rose LLP August 2011 05
Part 1 Feasibility What do we mean by bankability? The terms bankable or bankability will be used extensively in this guide. Bankability is essentially a view on the robustness of the project structure in terms of it being able to secure for the lenders full repayment of debt outstanding, either through project delivery and operational returns or, in a default scenario, through recourse against the parties responsible for project delivery. The considerations as to bankability will certainly vary from one project to the next, but the lenders will tend to have certain key requirements which must first be met in order to secure internal credit approval and the authority to lend. In the context of a Chinese debt solution, the same principles of bankability can still be applied, but the source of project scrutiny is likely to differ. Chinese banks will usually require some form of debt repayment guarantee from either the resident State of the Sponsors, or the parent company of the borrower. The Chinese lending structure is not limited recourse project finance of the type typically secured from western lending institutions and, in the context of the borrower procuring a parent company debt repayment guarantee, is more akin to corporate lending. Whilst the guaranteeing of debt repayment may not immediately seem attractive, the current liquidity gap in the western debt context and the lower margins on offer from Chinese banks can make this debt option attractive for those junior mining companies looking to secure large amounts of debt at a relatively low price. With debt guarantees in place, the level of project due diligence carried out by and on behalf of Chinese banks tends to be far more limited, and is usually carried out by the bank s in-house team. However, as a consequence of guaranteeing debt, it is likely that the State or the parent company guarantor (as the case may be) will instead be the party that will scrutinise the robustness of the project structure in terms of it securing project delivery and operational returns or, in a default scenario, permitting full recourse against the party responsible for project delivery. 06 Norton Rose LLP August 2011
Feasibility Feasibility General Before discussing the feasibility stage of a mining project, it would perhaps first be useful to clarify its purpose and to dispel a few common misconceptions. The purpose of the feasibility stage is to carry out an appropriate level of testing and analysis to establish if a project should be developed through into the detailed engineering and construction stage. It is important to recognise that completion of this study does not, in itself, mean that the Sponsors have an economically viable project. In fact, it can say just the opposite. Furthermore, adding the words bankable before feasibility study does not mean that the project is one that will secure project financing. A bankable feasibility study simply means a report with a sufficient level of accuracy to enable financial institutions to consider feasibility. The decision as to whether to lend will only come following the completion of further and more detailed due diligence. The feasibility study can therefore be seen in several lights. Provided the content is favourable and the report has been produced to the required reporting standards (eg, JORC, NI-43-101, SAMREC (as appropriate)) with a recognised international mining consultant or engineering firm standing behind the results, the report may be used for the following purposes: an important and valuable marketing tool which can be used to attract potential equity investors and/or lenders; a tool to be used by the mining company itself to secure internal board approval for the commitment of equity and capital for the progression to detailed engineering and construction; a tool to be used by the mining company in order declare a reserve on a new project, as provided by the US Securities and Exchange Commission (SEC); or Norton Rose LLP August 2011 07
Part 1 Feasibility a tool to be used by sponsors to satisfy certain pre-listing requirements (see for example the requirements for disclosure of ore reserves in Chapter 18 of the Listing Rules of the Hong Kong Stock Exchange). The common misconception that the production of the final feasibility study will, in itself, either provide the Sponsors with a feasible structure for project delivery and/or secure project financing, often means that fundamental steps are missed or forsaken by Sponsors in pursuit of obtaining the final feasibility report (whatever it may say!). As we will discuss below, this approach may have significant cost implications for the Sponsors. Stages of feasibility Sponsors should look to identify issues that may impact on feasibility at the earliest possible stage. It would be usual therefore for Sponsors to commission the carrying out of preliminary analysis on the reserve and its viability in order to identify key feasibility issues before significant amounts of money are committed to the production of a final feasibility study report. With the cost of a final feasibility study report often running to several million dollars, preliminary analysis can save significant costs later. Below are some of the keys steps typically taken during the feasibility stage of a mining project. As noted, the Sponsors should determine on a project specific basis the appropriateness of each stage of preliminary analysis and/or the requirement for additional stages of analysis both pre and post production of the final feasibility study. Conceptual study The feasibility stage of a project will usually commence with the production of an initial scoping or conceptual study. This conceptual study will typically involve a preliminary evaluation of the project based on initial drilling, industry experience and informed assumptions. The end product will provide a description of the general features of the project, technical factors requiring further investigation and an order of magnitude of likely capital and operating costs, with a usual accuracy of +/- 50 per cent. Whilst this report by no means provides an accurate assessment of feasibility, it can and should be used by the Sponsors to determine whether or not to proceed forward with an exploration program and further engineering work. 08 Norton Rose LLP August 2011
Feasibility Pre-feasibility study If the decision is made, following completion of the conceptual study, to proceed, the next stage in the feasibility process will typically be the completion of a pre-feasibility study. This is the key intermediate step in the assessment of project feasibility. Typically at this stage there will be sufficient drilling and process test work to enable the production of basic engineering. Pre-feasibility will typically involve a determination of mining and milling extraction methods, anticipated product recovery rates and consideration of key environmental and permitting issues. Again, preliminary capital and operating cost estimates will be carried out, this time with a usual accuracy of +/- 30 per cent. There should be focus at this stage on critical issues to be resolved during final feasibility if the decision is subsequently made to continue. Final feasibility study If the results of pre-feasibility are favourable, the Sponsors may chose to move to the final stage in the feasibility process and the production of the feasibility study itself. The feasibility study deliverables will typically include initial mine and plant design, detailed process flow sheets, product recovery estimates, detailed capital and operating cost estimates and an economic model for the project. It would not be unusual also for the feasibility study to present possible financing options. The feasibility study will typically produce results that are accurate to within +/- 10-20 per cent. Analysis and further investigation Although it would not be unusual for the final feasibility study to identify areas where further investigation may be required, we would typically expect this study to provide sufficient information to enable the Sponsors to make a decision as to whether to move to detailed design and construction or, if the results are not favourable, abandon the project. Whilst the three stage iterative process set out above is typical, it is not a process that should be considered as being set in stone. There may for instance be other intermediate steps that the Sponsors may wish to take before making the decision to commit resource to the further development of a project. Norton Rose LLP August 2011 09
Part 1 Feasibility It is however essential that the mining company carries out a full appraisal of the results at each stage of an iterative process to take stock and make an informed decision as to whether to continue to the next stage. The key at each stage is to identify problems to be resolved at the next stage and the means by which they may be resolved within the bounds of the economics of the project or (as the case may be) to identify those problems which are insurmountable and which should on reflection deter additional time and money being committed. This process is about drip feeding both time and money into the project and the right time for the right purpose. Other key feasibility considerations The Sponsors role at the feasibility stage Whilst a feasibility study is often produced by an experienced and recognised international engineering consultancy practice, the Sponsors still have a very important role to play if, on the assumption that a reserve may be declared, the feasibility study is to provide a solution that meets the economic expectations of the Sponsors and is acceptable to potential lenders. Whilst controls relating to equipment selection and parameters of affordability should be established under the terms of the consultant s feasibility study appointment, careful monitoring of the progress of the study at fixed milestones will enable the Sponsors at an early stage to pick up on (and ideally resolve) issues that may affect possible financing solutions or go to the affordability of the project. The Sponsors should be aware that equipment selection made at feasibility stage may impact on possible financing options, especially in the context of securing Chinese debt with export credit agency (ECA) backing. Sinosure (the official ECA for China), will provide political and commercial risk cover to support exports of Chinese goods and services. However, it will be a condition of providing such cover that the export contract (for instance, an EPC contract with a Chinese contractor) has a Chinese content of at least 60-70 per cent. If plant and equipment costs 10 Norton Rose LLP August 2011
Feasibility are likely to form a significant portion of the EPC contract price, Sponsors should look to work closely with the party producing the feasibility study to ensure that plant and equipment selection made at this stage will not lead to difficulties in achieving this Sinosure content requirement. There should ideally be close dialogue between the engineering consultant producing the feasibility study and the Sponsors throughout the final feasibility stage to allow refinement of the study and the assumptions on which it is based. It is also likely that interested lenders will be willing to offer input at this stage. It is advisable for Sponsors to tap into this resource where available. This interactive process is about pointing the consultant in the right direction to ensure that assumptions on which the final report is based correspond with the expectations of the Sponsors and any potential lenders. This exchange of dialogue must not however be viewed as a means by which the Sponsors can manipulate results to provide an answer they are looking for where a project would not otherwise be feasible. Contracting arrangements Whilst the production of the conceptual study and the pre-feasibility study may be based on more informal terms agreed between the Sponsors and the engineering consultant, or indeed carried out in-house by the Sponsors, the final feasibility study should be completed under the terms of a formal contractual agreement between the relevant parties to ensure that all key requirements of the Sponsors may be achieved. These key requirements will typically include (but not be limited to) the following: the final report to contain all required deliverables and to be produced to the required reporting standards; the engineering consultant to stand behind all results in the final study and to be responsible for any errors and/or omissions in the final study (in practice, consultants tend to look to cap their exposure in this regard to the value of the services provided or re-performance of the services); Norton Rose LLP August 2011 11
Part 1 Feasibility the consultant to assign all intellectual property rights in the feasibility study report to the Sponsors, or at least provide an irrevocable licence with a right to grant sub-licences (the Sponsors have to consider the possibility that other third parties may wish to rely on or use the report (eg, third party equity investors or potential lenders)); the final report to be completed within a certain time period to meet the Sponsors overall project programme with appropriate sanctions for delay; and a right for the Sponsors to review the progress of the report at fixed milestones and to require changes to the scope and/or the assumptions on which it is based. The contract will typically be a form of professional consultancy services contract. The consultant may propose a form of contract but this should be reviewed to ensure that the key requirements of the Sponsors may be achieved. There are also international forms of consultancy agreement that may be employed. For instance, FIDIC has produced a form of professional services agreement (FIDIC White Book) which is often proposed by engineering consultants. It is often the case however that amendments to this form are required in order to achieve an acceptable position for the Sponsors. Legal advice should be taken by Sponsors in this regard. Design development A fundamental consideration for the Sponsors should be the level of detailed design (if any) being produced at feasibility stage. Whilst a more developed design will permit more accurate capital and operational pricing prior to commencement of construction, the development of detailed design at feasibility stage can (and often does) have a real impact on construction pricing and ultimately bankability. The Sponsors should consider carefully the extent to which a third party engineering and construction contractor would be willing to accept responsibility for design developed by the engineering consultant producing the feasibility study. 12 Norton Rose LLP August 2011
Feasibility As we will discuss in part 2 to this guide, lenders will typically look for one party to accept full responsibility for all aspects of the delivery of the works (the so called single point of responsibility ). If the design produced at feasibility stage is conceptual and limited in detail, this may be less of an issue. However, if the design is more detailed, it may be less likely that a third party would accept full responsibility for the accuracy and completeness of any such design. In circumstances where there has been detailed design development at feasibility stage, the securing of a single point responsibility position may have significant cost implications for the Sponsors: In the first instance the Sponsors may be left no option but to complete the detailed engineering and construction phase using the organisation carrying out the feasibility study, as no third party may be willing to accept responsibility for this design. As the engineering consultants typically carrying out feasibility studies are often multi-disciplinary organisations, this may be possible. However, the Sponsors will of course be exposed to the risk of having to accept the detailed engineering and construction price proposed by this party, as there will no longer be any real competitive tension left in the procurement process. In the alternative, on the assumption that the Sponsors are able to find an engineering and construction contractor willing to accept responsibility for the feasibility consultant s design, it is likely the acceptance of such responsibility may be accompanied by a significant amount contingent risk pricing. Pricing exposure of this nature is actually a very common occurrence in the context of mining procurement. Of course, with planning, this exposure may be mitigated by requiring the party completing the feasibility study to commit to EPC terms and a construction price at an early stage in the feasibility process. This approach of essentially converting the feasibility study contract into an EPC contract on the Sponsors election can be employed provided that there is a degree of certainty as to scope and price at the commencement of feasibility and/ or provided that the degree of flexibility required in this regard can still provide Sponsors with an appropriate level of price certainty. Norton Rose LLP August 2011 13
Part 1 Feasibility Suffice to say, if the single point of responsibility position can not be achieved or would otherwise make the project unaffordable, the Sponsors may have to consider an alternative structure, which may impact on potential lenders views as to bankability. This is a common area where a lack of planning at feasibility stage can impact on bankability considerations at the project implementation stage and we will consider this further in part 2 to this guide. Feasibility stage key point summary The feasibility stage of a mining project is about the carrying out of an appropriate level of testing and analysis to facilitate the making of an informed decision on whether a project should be developed through into the final engineering and construction stage. The production of a final feasibility study report does not in itself mean that a project is viable or that the project will be one that will attract project finance, it can say just the opposite. If a project is not feasible, from a cost control point of view Sponsors should be looking to find this out at the earliest possible stage in the process. It is important that Sponsors take a careful and measured approach to the collation of data and information pre-final feasibility in order that an informed decision can be taken as to whether to commit the time and resource to the completion of the final feasibility study report. Simply jumping in at the deep end without first carrying out the type of preliminary analysis suggested in this guide can have wasted cost implications for the Sponsors if the project is subsequently deemed not feasible for reasons that should have been identified in the carrying out of initial analysis. In practical terms, the Sponsors should: 14 Norton Rose LLP August 2011
Feasibility stage key point summary establish at project inception the series of steps to be taken in order to achieve completion of the feasibility stage of a project; and where possible, establish the results and information required at the completion of each step to facilitate the making of a go / don t go decision in terms of whether to commit the time and resource to move to the next stage or to the detailed engineering and construction stage (as the case may be). The Sponsors should select an appropriate form of contract for completion of the final feasibility study to cover key Sponsor requirements. Advice in this regard should be sought from in-house counsel or external legal advisers. If any detailed design is to be developed at feasibility stage, the Sponsors should first consider what impact this will have on the pricing of the detailed design and construction stage of the project and more generally the impact this may have on the achievement of a bankable detailed design and construction contracting structure. The Sponsors should work closely with the relevant engineering consultant and seek input from potential lenders (to the extent available) throughout all stages of feasibility to provide increased certainty that the final deliverables will meet the Sponsor s and any potential lenders expectations. Norton Rose LLP August 2011 15
Part 1 Feasibility Contacts For further information, please contact: Mark Berry Partner Norton Rose LLP Tel +44 20 7444 3531 mark.berry@nortonrose.com Matthew Hardwick Associate Norton Rose LLP Tel +44 20 7444 5550 matthew.hardwick@nortonrose.com 16 Norton Rose LLP August 2011
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