Contractor vs Owner-operator. After an evening in which contracting was much discussed, I reflected that many people get hung up on the use of mining contractors and the supposed loss that occurs in paying the contractor's margin. If there is a rip off, it's invariably because the contract itself has been poorly scoped and the Principal has not put enough effort into providing Latent Conditions or Conditions Precedent to the contractor. This is the key - explain exactly what is to be done and then match the contract type to the job. And I've worked on both sides of the fence.
RULE 1: The mine owner (Principal) produces metal and the Contractor shifts tonnes.
There's a big difference. Contractors are in most cases are much better at maintaining equipment (which is their reason for being); purchasing machinery, spares and consumables in volume at attractive rates; running short-term mine schedules and running a tight safety ship (which is their reputation). Mine owners are much better at managing the technical sides of the operation (Resources and Reserves).
RULE 2: Contracts are about spreading risk
So, an efficient bog-standard operation owned by a junior will run a mining contractor. It spreads operational risk by reducing capital (the contractor supplies the gear) and increasing operational efficiency (the Contractor is better at digging holes than the Principal). The Contractor is responsible for operational under-performance and takes credit for over-performance. Even the Majors use contractors in the early years of their operations, which is the most risky period. A typical strategy for a long-lived operation is to have a contractor in for the first (say) five years of the operation, with a buyout clause in the contract on the part of the Principal, once the joint has been established.
My favourite comedy act (if it weren't so sad) bought a fleet of second-hand equipment (there's a really good reason why it's second-hand) and proudly proclaimed that it was owner-operator and avoiding contractor margins. All this on a poorly-defined orebody, without a Feasibility Study and with an untried processing plant. All the risk is on the part of the owner and the result speaks for itself.
A key consideration is the type of contract -
1. schedule of rates spreads mining risk wholly to the contractor and has a 40 year history in Australian mining: everybody understands it. Great for when the orebody and schedule is well understood
2. fixed and variable means that the Principal pays the contractor's project fixed costs (including insurance, which is important, because that gives the Principal considerable control over the Contractor) and pays for production at a schedule of rates. Great for when there is some uncertainty regarding the Resource because the owner retains some of the risk.
3. cost plus is generally only applied to short-term or emergency projects (the geo has found some more ore that's out of scope or the ramp has collapsed and both parties must work together to repair it) and requires an open book. There is no impetus on the part of the contractor to reign in costs.
4. Some form of partnership - either reimbursable costs plus a performance bonus or an alliance. Generally applied to very large projects, where the owner and contractor are sharing a very large capital cost. Think BHP-Mitsubishi (BMA) in coal - the customer (Mitsubishi) is also the equipment supplier (through the Japanese equipment manufacturers) while the owner supplies the Resource and technical expertise. Risk and reward is shared by both parties.
AN interesting behavior is Northern Star, where the company has significant contractor experience (Billy took all his mates with him) and runs what's effectively an internal contracting business within a mining company.
So, in most cases for an investor, if an outfit is going owner-operator on a new project, particularly is that project is overseas, unless there's a really good reason, contracting is the way to go because it reduces risk to the owner.
