Part 7 in the series ‘Development of Mining Projects from Scoping Study to Commissioning successfully for the benefit of your shareholders
Sten Soderstrom
Available on mobile MINING NED, CHAIR, PROJECT DEVELOPMENT & TRANSFORMATIONAL MANAGEMENT EXPERT, ENTHALPHY Associate, >30 YEARS' INTERNATIONAL EXPERIENCE . MAusIMM, Fellow Chartered Professional Engineer, FAICD.
There Are Projects That Sometimes Fail To Meet Expectations Because Of A Lack Of Thorough Preparation And Planning According To ‘Best Industry Practices
In Part 6 we discussed the importance of Building and Maintaining a positive People Culture.
In this Part 7 we look at the considerable challenges that CEO’s face in dealing with the complexities of how to best manage and coordinate all the elements of the strategic objectives, the project plan and achieving positive outcomes for all stakeholders.?
Pre-emptive bias
During the early phases of new projects, there is always pressure on the executive team to reach a stage where the company can make a positive statement to the stock market. This pressure, which is often referred to as CEO bias or pre-emptive bias, is then transferred to the project, which is required to produce results that line up with the company’s announcements.
The pressure placed on the project takes a number of forms, including the need to complete a mine plan that supports a reasonable production level and a push to finalise metallurgical testwork, which is critical to most mining projects. In the case of metallurgical testwork, this pressure can include factors such as when the executive team makes the decision to declare that testwork is complete, and how the cost and time to perform additional testwork may affect the economics of the project.
The need to stay on track with the company announcements can lead companies to take all kinds of shortcuts and omit vital stages in project development. The irony of this is that these factors often contribute to the failure of the project.
Gearing Ratio and Free Cash Flow
Aside from the pressure to rush things through and cut corners, project finance can be a problem. If a project relies on a high gearing ratio, which is typically over 75% of the project cost, the project viability becomes highly sensitive to the ultimate capital and operating cost.
This is because the higher the gearing ratio, the greater the proportion of free cashflow used to service the debt. Unfortunately, if the costs blow out, the revenue isn’t as high as expected because you’re not producing as much as you had anticipated, or if the price of the product goes down, you can end up in a situation where there’s nothing left for the shareholders, and the share price will drop.
On the other hand, if there is insufficient finance in place and the company needs to seek further funding, the project may fail because the market perceives that the initial proposition put forward by the company could not be relied upon, so why should another fundraising activity have greater credibility?
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Example: Unforeseen Circumstances?
If the project goes ahead, the following scenario can develop. Although this is a generic example, there are many situations where this pattern has played out.
Month after month, the CEO and board receive upbeat progress reports on a new project, stating that everything is on target and within budget. Everyone feels very pleased, gives each other a slap on the back, and celebrates how well they are doing. Gradually the reports become less positive. These less-than-glowing reports will run along the lines of “unforeseen circumstances” and “underperformance by contractors.”
At this point, the budget for the project begins to look unachievable, and the CEO will have to go to the board to have a “revised budget” approved. This then becomes the new benchmark. The past is forgiven and everyone moves on.
The problem is that none of the underlying causes have actually been resolved, and so the whole process may well be repeated, until it becomes embarrassing.
Once it becomes clear that the project is in trouble, the blame game starts, and the hunt is on for the guilty. Heads roll, and people who are needed leave to go on other projects.
Rather than pointing fingers, it would be better to take a step back at this stage and ask a number of questions, such as:
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Beyond Our Control
?If you’re running a publicly listed company, or if you are in the stages before the initial public offering, rather than asking questions like those in the above example and addressing the underlying reasons for any difficulties the company is struggling with, the inclination is to save face by stating that the things that have gone wrong are beyond your control.
?Unless you can demonstrate that things are genuinely beyond your control, my experience is that in the majority of cases everything is well within your control and the things that go wrong have simply not been given enough attention in risk management or have not been executed well.
There are several reasons why things may not have done properly. It could be due to lack of knowledge, deliberately avoiding the problem, or because the company, due to lack of cash, starts to minimise expenditure during the pre-investment-ready stage.
Financial project structuring needs to be planned well in advance, so that you have a viable step by step plan for the project and are not left in no-man’s land with nowhere to go.
Case Study – Gascoyne Resources
?Sean Smith, a senior business and resource journalist, wrote in The West Australian newspaper when the company went into administration:
"Gascoyne Resources is representative of the worst side of the gold industry.
Another junior wannabe which raised considerable amounts of money to build a new mine on the basis of promises it hasn’t met.
The industry has a woeful development record. If it’s not struggling to deliver new projects on time and budget, it’s struggling to get them running to expectation.
And too often the solution is just to throw more money at the problem rather than cutting their losses and walking away from what are ultimately marginal projects at best.
Gascoyne’s Dalgaranga mine is a money pit. If it can’t turn a profit with gold prices at a five-year high of nearly $1900/oz, the project shouldn’t be in operation.
In calling in administrators, Gascoyne directors are believed to have been influenced by a desire to protect the company’s cash. Shareholders who contributed to last month’s $24 million equity raising will argue they should have pulled the plug a month ago.
Going into administration after raising a big lick of cash is not a good look for the company’s former directors or the two broking firms who helped offload the stock.”
This article reflects a sentiment about the industry and its failure to deliver projects on time and on budget, let alone getting them running to expectation. It also reflects badly on the gold industry in terms of bringing in projects which can’t provide shareholders with a return on their investment, despite record-high gold prices in Aussie dollar terms.
There are projects that should never get off the ground. After all, companies are formed for the benefit of shareholders. They’re not formed for the benefit of the directors.?
The Personalities Behind The Project
?It’s not all doom and gloom, and I have seen situations where actual results have exceeded the predictions of forward-looking statements. This is very largely due to the personalities behind the project.
There are certain leaders in the industry who have a track record of successfully developing projects in the past. This has a very positive impact on institutional investor’s and the general public’s willingness to invest in their companies, because investing in mining is speculative.
So a company that is formed and which has people involved that nobody’s heard of is unlikely to raise as much money or achieve the sort of share price that an equivalent company backed by individuals who have a long track record of success will be able to secure. This means that the individuals behind a company are always going to be important.
It is worth remembering that the people with a great track record started out with a blank sheet, but they consistently overcame the obstacles that could have held them back. If you make the right moves then you can build a great reputation.
Despite the fact that mining is always going to be a bit speculative, there are many things that you can do to shorten the odds. For example, going back to metallurgic testwork, you need to have a clear understanding of the project you are working on in order to know how extensive the testing should be.
When it comes to base metal projects and DSO (direct shipping iron ore), which involve fewer processes, the testwork is of less importance. Moving onto gold, the testwork becomes more complex because gold can exist in many forms and the process plant design and performance depends heavily on testwork. For this reason, the metallurgic testwork for gold is far more crucial, and the testwork needs to be far more extensive in order for you to ensure you are making the best decisions.
However, there is a point at which it becomes a case of diminishing returns.
But when you get to polymetallic projects, where you have an ore body that contains four or five different metals, extracting those different metals requires a far more complex plan and a far more complex set of testwork and pilot work. This means that the testwork can be quite expensive and time consuming. So, the amount of testwork you do depends on what type of project it is and how well you pursue achieving optimal extraction.
This is just one reason that the amount of upfront expenditure on a project can accelerate rapidly.
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Alternatives To Value Creation To A Stand-Alone Project
?Strategic value creation from in-ground mineral assets does not necessarily mean that you have to build a project. In the early phases of considering what alternatives are open, economics may point you in the direction of joint ventures, divestment, company mergers, asset sale, farm-in agreements and so on.
In many cases, these alternatives may offer a better outcome for shareholders, than hanging on in the hope of increased commodity pricing, further near-field discoveries, etc.
领英推荐
The following case study illustrates these alternatives as well as highlighting the main differences between the major- mid-cap and junior gold companies as seen by a key figure in the industry.
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Case Study – Resolute Mining Boss John Welborn
John Welborn, in an interview published in the West Australian Newspaper on August 1, 2019, when queried on recent merger and acquisition activity in the gold sector, lashed out at smaller miners that resisted value-creating consolidation opportunities.
“It’s an irony to me that at the top end of the gold space, where salaries are in tens of millions and the egos are bigger, you’re actually having positive shareholder value-creative M&A. But at the mid-cap and junior space, you have boards and management teams that are welded onto their salaries like a baby to a teat, and a complete lack of entrepreneurial vision in terms of consolidation.”
“There are wonderful opportunities to consolidate and build this industry but a lot of people are sitting on their ounces that they don’t know how to manage properly.”
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Lack Of Relevant Experience?
A common cause of projects failing to meet cost, timeline, and performance objectives is the lack of relevant experience by the senior executives.
This lack of experience shows up as failing to follow “best industry practices” or failing to produce a comprehensive project development plan. This plan should answer all the questions about how you are going to develop the project, what standards you are going to apply, what resources you’re going to use, and what it is going to cost.
?It can also relate to key contractual conditions which are entered into between the company and a service provider or construction company. The failure to grasp what these conditions mean leaves the company exposed to significant risk.
When bad choices are made early in the project—for example, due to a failure to recognise that operating companies have very limited, if any, experience in establishing and managing a project—things can get messy very quickly.
Often this occurs because there hasn’t been any independent review or audit of the project. In many cases, what happens is that an EPCM engineering company is engaged in the hopes they will act in the best interest of the company. However, engineering companies are mostly interested in the fees they can generate from the work undertaken, rather than the viability and profitability of the project.
When things start to look awkward, the project team may be told by the CEO to “make it work.” This then leads to decisions being made for the wrong reasons, creating a lack of credibility in the project. In the end, it all comes back to how closely companies have followed “best industry practices”.?
“Best Industry Practices”
?This is a term that people love to use, often making the claim that they follow “best industry practices”. However, they often don’t have much to back up the claim or a clear definition of what it means in the context of the company and its strategic value creation processes. In fact, they might not even necessarily know what the “best industry practices” are, but it sounds good.
It would seem to be a given that people would understand “best industry practices”, but there are a number of areas where people fall down. Without having these basic building blocks in place, companies will always struggle to optimise their value creation.
There are many examples of project successes; however, there are also many examples of failures that I’m aware of, and in every one of these failures, there is a lack of adherence to ”best industry practices.” But people will rarely own up to what the real reason is for the failure, even if they are aware of what that reason is. Common failures regarding “best industry practice” include:
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The cost of failing to meet expectations due to lack of thorough preparation and planning in accordance with “best industry practices” can be measured in many different terms such as the project’s net present value (NVP), the internal rate of return (IRR), or the payback period.
No two projects have the same cash flow streams. However, most projects are highly sensitive to increased costs and delays to completion in terms of the NPV. This means that the value of the project to shareholders is also very sensitive to cost and timelines.
The simple fact is that the price of a share in any company is based on expected future earnings. Cost overruns invariably result in revenue reductions many times larger than the cost overruns. It is for this reason that the effect on the share price can be significant, with obvious impact to the board of the company.
For the individual executive, the failure to meet expectations can mean a major setback in career expectations and in some cases may even lead to termination. There is also a potential for the board to be in breach of continuous disclosure obligations under the listing rules.
This can happen once things have got to a point where everybody knows it’s not working, but nobody wants to admit it.
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Key Takeaways
For your organisation there is a solution for achieving your objectives
?If your ultimate objective is to add more strategic value to your organisation, which in turn increases the market capitalisation of your company, then I can help you ensure it’s a win-win for everyone.
?To find out how I can help your organisation, drop me a line or call. I am based in Perth, Western Australia.
Sten Soderstrom (FAICD, FEngAus, CPEng, MAusIMM)
DIR ID 036 62566 41832 63
0418918310
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Links to earlier Parts in Series:
Part 1:
Part 2:
Part 3:
Part 4:
Part 5:
Part 6:
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