sector consolidation, page-5

Hi fitnfam,

I had a think about your costs example (re your reply to Paul13). Please allow me to offer some general information on cut off grade application:

1. Lower grade material must never displace higher grade dirt through the mill, hence your comments on plant capacity are very valid. The marginal revenue from mining increasingly lower grade material must exceed the cost of mining and milling that lower grade material as well as recognising your comment about capacity. The capacity issue essentially means that you risk displacing your high grade schedule because you decide to move and treat some low grade.

2. Capacity must also exist in the whole mining stream because a mine can only produce at the rate of its slowest process. Eg, there could be problems with dirt supply from the pits or underground. It might be the blast hole drills or the digging rates etc etc. These are often easy to fix and result in cheaper mining, ie doing more with the same gear. Easy...if you know what to look for and what to do. This is what all mines should do anyway.

3. Decisions to mine and process lower grades must be made properly so that shareholder value is not destroyed. There are two types of low grade material; i.)Material you have to mine anyway and, ii) low grade material you decide to mine additionally to the pit boundaries or u/g stoping schedule you have as your base case. Mines have to know what their fixed and variable costs are. In a marginal cutoff grade calc, most fixed costs can be removed until you need a step change in labour and equipment because of the extra amount of material you decide to mine and call ore (ore is an economic term and ofen used incorrectly, ie anything shiney is often called ore, this is not necessarily so).

3a.In a pit, you have to remove all of the material from that pit, ie both ore and waste. This means that the marginal cut off grade is actually the cost of milling and sales. You generally don't have to include the mining cost because you incur it regardless whether you decide the material is ore or waste! The decision to waste or treat material can be made when the truck reaches the top of the pit and you can apply cut off grade theory on an hourly basis if you really wanted to.
But there is another low grade treatment scenario. If FML decided to 'optimise' their pits on a higher gold price, any number of pit boundaries would have to be 'pushed back' and that is an investment decision where the marginal cut off grade outlined above will not suffice. Any material mined from a push back must pay back the capital cost of removing the waste as well as the operating mining costs. These decisions must include what the plant can do, because you could significantly increase the amount of material you classify as ore. You often have to spend money in the plant to increase its capacity to treat your reclassified ore tonnes. There is no point mining a heap of extra dirt only to have it sit around for a while or displace your higher grade material (low grade stockpiles should only exist if you have to mine the material to get to the hogher grades, ie it is valid to apply the marginal cost which is the milling cost as I outlined above). So lets say you decide to invest and mine lower grades. Everything goes well until the gold price drops. When the price drops, you may only be half way through mining the extra material you have invested in, ie all of the waste cover has been moved. If the material is no longer covering the full operating cut off grade (ie the mining and milling costs, you have to include the mining cost because this material is additional to the pit you were originally mining), you should abandon mining the low grade dirt. Trouble is you've spent the money to move the waste cover material and expand the mill and you won't pay it back hence destroying shareholder wealth. If the gold price goes up, thats great and everyone pats each other on the back. These lower grade investment decisions are entirely dependent on FML's outlook on the gold price and properly applying cut off grade theory.

3b. Lower grades from underground: U/g cutoff is a bit more tricky but follows the same logic, particularly around the capacities. U/G mines using the mining method that FML uses have to select their ore way in advance of mining it. Remember that open pits can determine what is ore and waste as late as when the truck gets to the top of the pit. Stope mining methods can't do this (or shouldn't do this). Marginal cutoff grade in an u/g mine like FML's must include the extra drilling, charging, bogging, trucking as well as the milling costs. Remember that open pit mines can (but don't have to)apply a marginal cost that is equal to their milling cost. Marginal material underground can be found in development (tunnel) faces that have to be mined regardless of ore or waste (so long as they pay for the costs mentioned above). Marginal material can also be found where stopes are surrounded by low grade halos where extending a few drill holes to pick the material up is easy (other costs often apply but explaining this is time consuming).
The other low grade scenario follows the same logic as the open pit push back. If you decide to go and mine a low grade deposit that is separate from your main mining area, you have to make an investment decision (ie inlcude all costs) and the same thing can happen as outlined in the pit scenario (gold price drops - crap decision, shareholders upset, gold price rises - shareholders write nice things about management on hotcopper).
One last thing is relevant and its a kind of catch 22: if you mine down into an area in an underground mine or open pit and the grades are lower than you are expecting you should re-examine your cutoff grade (after you have removed your pineapple) because the money you have sunk into mining has no effect on the cutoff grade. Cut off grades only look forward and so long the future revenue exceeds the future costs you should mine, you just won't make as much money and you risk not paying back the capital you've invested to get there in the first place.

In summary, the decision to mine lower grades must be made very carefully, recognising that there is easy low grade and trickier low grade. Its very hard to quickly turn a mine around that has geared up to mine lower grades.

One more comment: in times of high prices, there is an argument to increase your cutoff grade (if your deposit allows it) so you make money hand over fist and your NPV is cranked. This however seriously mucks around with mine life and the government doesnt like this because the deposits belong to the good people of Australia (royalties, jobs etc).

Type in Ken Lane's theory of cut off grades into a well known search engine. It'll either fascinate you or send you to sleep. I advise having alcoholic beverages within arm's reach if you find the latter.

Please DYOR.