Financial Intelligence applied to Renewables for Mining

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Times for mining are changing

Before the commodity boom, according to industry experts, mining was focused on ramping up production and investing in new capital projects to expand supply. After the boom however, the world mining has re-focused on cost control and capital discipline. Currently, investors value firms based less on what they mine and more on how efficiently they do so. In this new scenario, non-conventional renewable energy (NCRE) sources are able to mitigate energy risks in mining. This fact is because renewable facilities act as mining assets whereas business as usual (BAU) energy options, not only oil and gas, but large hydro develop as mining liabilities.

During 2015 the downward pressure on profits of mining commodities will be even stronger, not only for the end of commodities cycle but by the dollar appreciation as well. Oil is relatively cheap, but Saudi Arabia cannot follow the oil price war for more than a year and a half. The increase of dollar exchange rates most of importing commodities countries as China, India and, in minor rate, Europe compensate last months of decreasing trend of oil prices, even worse if the this trend change in a year and the dollar follows growing up.

Will these risks transform into a real scenario for mining? Of course will do.

Therefore the real question is not how renewables for mining will fight against the current price of energy in terms of usd / oil barrel. The dangerous question survives on the assumption that if this energy short-term mirage, Siren songs, will delay the necessary transformation of the energy matrix in global mining. The new paradigm of the non conventional renewable energies.

Financial Intelligence, a new paradigm for renewables in mining

I think the industry needs for a financial paradigm shift. The success of renewables in other industries were based on financial innovation more than in technology. Financial intelligence would help mining as a “Bridge over troubled waters”, the industry urgently needs and deeply meditate how to measure the risk of Business As Usual (BAU) energy approach and the Opportunity Costs about renewables for mining. Here you have my humble contribution in finding innovative solutions for energy in mining, the renewables for mining Key Performance Indicators (r4m KPI).

Based on Financial Intelligence approach of BERMAN & NIGHT (2013) in understanding balance sheet basis , there is a puzzling fact about financial statements as follows.

Profit & Loss versus Balance Sheet Approach

If a project engineer proposes a renewable energy project of a mining company to an experienced manager business, minor or NCRE developer, the first thing he will turn to is the income statement, to the potential savings. Most managers have, or aspire to have, “profits and loss responsibility”. They are accountable for making the various forms of profit turn out right. They know that the income statement is where their performance is ultimately recorded. So that is where they first look at NCRE potential savings on the income statement.

Now try giving the same set of financials to a banker, an experienced Toronto investor in mining or maybe a veteran board member of a mining company. The first statement this person will turn to is invariably the balance sheet. However it is likely the project will not appear on the company’s financials as nobody has thought to include the NCRE project on the balance sheet. In fact, she’s likely to pore over it for some time. Then she’ll start flipping the pages, checking out the income statement and the cash flow statement –but always going back to the Balance Sheet.

Why do energy development or mining managers limit their attention to the income statement? This is mainly due to three factors. Firstly, balance sheets are a little harder to get your mind around than the income statement when we talk about renewable facilities for mining. Secondly, most companies’ budgeting processes focus on revenue and expenses. Finally, managing the balance sheet requires a deeper understanding of finance than managing an income statement.
Therefore, the industry needs a new method to measure risk and opportunity costs and their corresponding key performance indicators (KPI).

Financial intelligence on NCRE in mining focuses on understanding how NCRE financial results are measured and what you as a mining manager, employee, investor or leader can do to improve the results. I do not get into the esoteric elements of the mining balance sheets, just the ones you meet to appreciate the art of the statement and do the analysis that these statements makes possible. So let me explain some point about the basic points about the methodology of measurement.

Basic Points about the Methodology of Measurement

If we plan to do comparisons between BAU energy and NCRE in mining leaving in constant terms the rest of the variables (commodity, prices and other expenses), then we apply the expected price of electricity for next 10 or 20 years based on international standards forecasts (among others, the International Energy Agency), then we will be able to measure energy risks and costs opportunities for mining. In doing so we can represent the variations in mining profits or losses as «incomes» and addressing them as assets and / or net worth in the Balance Sheet. And when we carry on these calculations in terms of mining production or electricity consumption units, i. e. tonnes, ounces, KWh or MWh, we create Key Performance Indicators, which measure The BAU Opportunity Risks and the NCRE Costs Opportunities for Mining.

These are the fundamentals of r4mining methodology, the Renewable for Mining Key Performance Indicators (r4m KPI) and the collateral BAU KPI (bau4m KPI).

Viewing some results and conclusions

The r4m KPI measures the opportunity cost using renewables and the bau4m KPI will measure the opportunity risks using conventional energies.

Let’s examine 100 MW of solar energy for a big copper mine at Chile over 20 years based on current energy demand per copper tonne ($4.94/TMF) and a present-day commodity price of $6,696/t (November 2014).

Over the 20 following years the 100 MW solar power facility with an upfront investment Capex of US$155 million, it would generate US$162.15 million of mining assets versus Business As Usual would show up US$411.4 million in liabilities .

Furthermore the average valuation of the solar PV facility would achieve US$195.92 million on annual average, which means a higher quantity than the total upfront investment Capex for the deployment of this solar power facility.

Even better, this quantity would exceed than 120% of any financial collateral needed to finance this kind of project. And if we do so this way, the credit rating of the company will be substantially better. Credit rating will upgrade because savings (or indirect incomes) generates better cashflow and because WACC would drop thank to great decrease in environmental, corporate social responsibility risks and thanks to the protection against future threats in mining restrictive legislations.

In summary, the renewable facilities increase mining EBITDA and decrease mining WACC, therefore the mining company value will grow valuation and collaterally, the shareholder value.

Literacy Action Plan about r4m KPI

Since January to march 2015 I will weekly publish a collection of 10 articles explaining in detail this procedures you are able to follow in this newsletter. My goal is to help to you on Key Performance Indicators, but also to learn about your comments, thoughts, and inquiries.

Merry Christmas and Happy New Year 2015.