EDITORIAL — The spread between cash costs and all-in’ costs — Mining ore

. . . or not?

Maurice Brown, former editor and publisher emeritus of The Northern Miner, was an enthusiastic supporter of the mining industry during his 43 years with the paper. Mort, as he is affectionately known, is retired now, but his constant reminder to young staff writers — “It isn’t ore unless it can be mined at a profit” — lives on in the newsroom today.

The definition of what constitutes “ore” is more important than ever, particularly in the gold sector, where producers are facing depressed prices for the precious metal. That means everyone is paying more attention to the costs incurred by each company to produce an ounce of gold. Obviously, those at the bottom end of the cost curve have the best chance of surviving weak prices.

We, too, are interested in how producers rank according to their cost profile. The only problem is that mining companies use different methods and accounting formulas to determine the cost of their production. And we are not the only ones to struggle with the quandary.

Investors, who have far more clout than we have, are starting to complain that one man’s definition of “cash costs” can vary dramatically from the next man’s.

A recent investment report by Canaccord Capital notes that investor frustration over the confused accounting of costs per ounce has encouraged the industry to standardize the reporting format. This effort is being channelled through The Gold Institute, which represents most of the Western World’s major producers.

The cash operating cost takes into account direct mining expenses, stripping and mine development adjustments, third-party smelting, refining and transportation costs, and byproduct credits. Authors Glenn Brown and Richard Gray say the new standard differs from previous formats in that it includes royalties and production taxes to arrive at the total cash cost.

The total production cost is calculated by adding the total cash cost with depreciation, depletion/amortization and reclamation and mine closure. It does not include exploration and general administration costs.

The effort to standardize the reporting format will help investors make peer group comparisons. But, as Brown and Gray point out, that is only part of the story.

The profitability of a gold producer involves more than just the gold price, cost of production, and fundamentals of supply and demand. Technical factors such as geology and engineering also come into play, as does the quality of management. A good operating company with a sound technical team can make “ore” out of what might be waste for a less competent and experienced group.

Processing expertise is another important, and often underrated, factor as more and more deposits are discovered with refractory or otherwise complex mineralization.

Brown and Gray suggest also that investors should watch for mining companies that encourage their employees to produce innovative ideas that save on operating costs. Examples are the trolley and dispatch systems at Barrick Gold’s Goldstrike mine in Nevada, and the use of larger-tonnage trucks at various other operations worldwide. Another source of cost-saving is the ability of companies to maximize their selling price through sophisticated use of hedging, forward selling and other such mechanisms.

All these factors are relatively easy to assess and define. But the one quality necessary to be a long-term player in the gold business — exploration success — is perhaps the least tangible to quantify.

The bottom line for all producers is that before mines can be made, they must be found.