Page 291 - Introduction to Mineral Exploration

274 B. SCOTT & M.K.G. WHATELEY

Equity traditional methods. Thus companies have
This is finance provided by the owners (i.e. sought other methods of financing which made
shareholders) of the company developing the an optimum use of their financial strength and
project through their purchase of shares in the technical expertise but preserved their borrow-
company when it is floated on a stock ex- ing capability as much as possible. One method
change. Throughout the life of the mine these of achieving these ends is project finance.
shares may be bought and sold and if the mine
is successful they may be sold at a higher price
than their original value. Another return to Project finance
shareholders is dividends on each share which Project financing differs fundamentally from
are paid out of profits after other financial com- traditional financing. The organization provid-
mitments have been met. A successful mine ing the finance for the project looks either
may pay dividends from the start of production wholly or substantially to the cash flow of the
to the end of its life but for many mines fluct- project as the source from which the loans (and
uating mineral prices mean that dividend interest) are repaid and to its assets as security
amounts vary dramatically from year to year. for the loan. In this way mineral projects are
Usually a reduction in the dividend leads to a financed on their own merit rather than from
drop in the share price (Kernet 1991). the cash flow of the mining company that is
promoting the scheme (the sponsor).
Debt Lenders to the project like to see security
In this case money can be supplied by sources attached to the revenue of the cash flow in the
outside the company, usually a group of banks. form of firm sales contracts for the mineral
Debt finance places the company in a funda- products. It is common for them to form a con-
mentally different position than that of equity sortium to spread any lending risk as widely as
financing. Lenders may have the power to practicable. Project finance is then a type of
force it to cease trading (i.e. close down) if nonrecourse borrowing, which is not depend-
either interest charges or loans are not paid in ent upon the sponsor’s credit. However, for this
a previously agreed manner. Thus, ultimately, the sponsoring company isolates the new
control of the company is in the hands of project from its other operations (Fig. 11.9) and
the suppliers of finance and not the mining usually has to provide written guarantees that
company itself. it will be brought to a specified level of produc-
tion and managed effectively.
Retained profits Banks prefer to have a safety margin as pro-
A successful company may retain some of its tection against a deterioration in the project
profit and not distribute all of it in the form of cash flow. They will therefore agree to finance
dividends to shareholders. In this way a source only a proportion (say 60–80%) of the cost of a
of finance can be accumulated within a com- project with the sponsor providing the remain-
pany that is preparing to develop a mineral der. Full debt financing is rare. Two important
property. considerations which decide this proportion of
The traditional means of financing mineral finance are the length of the payback period
development in the first half of this century (see earlier) and the quality of the management
was a combination of the issue of equity, debt who are to bring the new mine into production.
finance, and the use of retained profit. This If the loan is to be repaid over a relatively short
method was adequate while the capital cost of period of time (say 3–5 years) a bank will be
development was millions or tens of millions more likely to lend a larger proportion of the
of dollars. During the last three to four decades total capital cost. Management is perhaps the
the capital cost and size of major mineral paramount factor in the evaluation of a project.
projects has increased rapidly and large projects Bad management can destroy a project which
now cost several hundreds of millions of dol- good management could turn it into the next
lars, possibly a billion dollars. With these levels Rio Tinto plc!
of expenditure very few, if any, mineral com- As a final comment it should be remembered
panies are able to finance new ventures using that the lending banks and the sponsor have a