Special to The Northern Miner
Production cost has always been an important measure of the relative health of a gold producer. Now, as bullion prices flirt with 20-year lows, it has become a glaring indicator of a gold miner’s chances for survival. If a company cannot produce gold at a cost far enough below the selling price to generate cash flow for capital expenditures, debt repayments and growth, its prognosis is grim.
Yet even as the industry increasingly relies on cost to judge performance and 1998 annual reports overflow with references to “record cash costs,” the term remains misleading, subjective and, to some, a dangerous measure of profitability.
“The costs (the producers) give to analysts are all apples, oranges, pears and plums,” says David Constable, vice-president of investor relations for
Development costs, for instance, are usually capitalized, while direct mining costs are expensed. But there are exceptions to this rule.
“When you’re doing developmental work but mining at the same time, what happens there?” asks Larry Strauss of Canaccord Capital. “Different companies will handle those costs in different ways.”
Which cost was that?
The Gold Institute, a Washington, D.C.-based industry group, attempted to introduce uniformity into the system in 1996 when it developed a voluntary standard for reporting production costs. Although almost all North American producers use the Gold Institute Standard (GIS), there are still three different ways to report costs.
- The first category — and the one highlighted in most annual reports as “cash cost” — is cash operating cost. This category includes direct mining costs and stripping and mine development expenses, as well as smelting, refining and transportation costs. Gold producers can use byproduct credits to offset these costs at mines that contain other metals, such as silver or copper. For example, the cash cost of producing an ounce of gold at Barrick Gold’s (abx-t) Meikle mine Nevada was US$78 per oz. in 1998 but with byproduct credits, this figure dropped to US$77 per oz.
- The second category is total cash cost, defined as the cash operating cost plus any royalties and production taxes. In the Meikle example, the cost of producing an ounce of gold jumped to US$97 per oz. after royalties and taxes.
- The final category is total production cost, which includes non-cash items such as depreciation, depletion and amortization as well as mine reclamation and closure costs. The total production cost at Meikle last year was US$155 per oz.
While the analysts and companies interviewed are, for the most part, satisfied with the GIS methodology, some find it misleading.
“It’s not a great standard,” says Normandy’s Constable. “Companies keep reporting lower and lower costs, but these costs are a little less than real.” Constable’s colleague in Australia, Executive General Manager Colin Jackson, is spearheading a campaign to have the standard changed to reflect more accurately the “real” cost of producing an ounce of gold.
Jackson could not be reached for comment, but a recent presentation to analysts suggests he is particularly concerned with the practice of using byproduct credits to offset cash costs at mines where the byproduct (for example, silver) generates a significant percentage of revenue.
Total cost transparent
Total production cost, although usually buried at the back of annual reports, is the most transparent measure of the long-term health of a gold mining company.
“At the end of the day, you want to get your total costs, cash and non-cash, below your realized price of gold and ideally below the spot price of gold,” said one gold analyst who requested anonymity. “What we really look at is the ability of the company to generate cash from any given mine.”
This view is shared by
“Total cost is becoming a more important measure of profitability,” says Placer Dome spokesman Hugh Leggatt. “We’re not assuming the gold price will ever go up, and we want not only to be profitable but to generate a 10% return on capital.”
While Placer maintains a healthy margin between what it pays to produce an ounce of gold and what it reaps in return, many companies are losing the battle to generate cash flow in the current price range of US$270-280 per oz. The average total production cost for North American gold companies producing 200,000-1 million oz. per year was US$303 per oz., according to data supplied by Canaccord Capital. The average price of gold during the same period was US$294 per oz., though some of these companies would have remained profitable by hedging production at higher prices.
It depends on the currency
The cost calculation is further complicated by external factors that influence cost, and some of these fluctuate from year to year. For instance, the major component of 1998 savings at mines in Australia, Canada and South Africa was the depreciation of these currencies against the U.S. dollar, according a study by AME Mineral Economics. Producers report their costs in U.S. dollars, but pay their expenses in local currency. When these currencies increase in value relative to the greenback, costs will rise.
The age of a mine also affects total production costs but has no impact on cash operating costs. Amortization, depreciation and depletion charges on a new mine are higher than for older mines.
Belt-tightening works
Regardless of reporting methodology, the sector has been successful in reducing costs in response to declining gold prices. According to the AME study, cash operating costs for Western World producers dropped 17% to US$193 per oz. in 1998 and are forecast to fall, in real terms, to US$177 per oz. in 2002.
There are three ways a company can control costs. The first is to introduce operating efficiencies by, for example, increasing mill throughput or reducing waste. The second is to acquire low-cost deposits. The third is to mine high-grade areas of the mine selectively, though no miner would admit to “high-grading,” as it ultimately hurts the bottom line by reducing mine life. “Our higher-cost producers have been achieving savings by controlling discretionary expenditures and by increasing the availability of their equipment,” says Leggatt. “We’ve also been improving our portfolio. All three of our major projects [Las Cristinas in Venezuela, Getchell in the U.S. and Western Deeps in South Africa] are large, low-cost deposits that will keep our costs low over the long term.”
Placer’s average total cash cost dropped to US$149 per oz. in 1998, compared with US$202 in 1997, while its total production cost dropped to US$220 from US$282. Placer’s main rival, Barrick Gold, has also been on a cost-cutting spree, as witnessed by the closing of high-cost mines.
“We’ve always put a premium on the need to keep costs low,” says Vince Borg, vice-president of corporate communications for Barrick. “But it was in 1996 that we intensified our efforts. The whole workforce is focusing on it.”
As a result, Barrick’s cash operating costs are expected to fall to US$125 per oz. this year, the lowest ever recorded for a major gold producer.
Savings include a US$1-million reduction in heating costs as a result of re-engineering the thickeners in the process plant at the Goldstrike mine in Nevada. Miners have also built a lightweight bed for the company’s 190-ton trucks, allowing the trucks to haul 14 more tons of ore on each trip. Barrick’s new roaster, scheduled for completion in mid-2000, will also reduce overall processing costs by 10% at Goldstrike.
Juniors hold their own
But cost-cutting success is not exclusive to the major producers. Many junior companies mining traditionally high-cost gold vein deposits in Canada are also managing to hold their own despite low gold prices.
mines, near Wawa, Ont., produced 88,480 oz. gold in 1998 at a cash operating cost of US$174 per oz., up from 75,484 oz. at US$211 in 1997. The improvement is partly the result of increased throughput at the mill, where capacity is being expanded from to 900 from 600 tons per day, says Michael Power, vice-president of corporate development.
“The Eagle River mine is in its fourth year now, so we have a better understanding of the orebody and the best mining method to use,” he adds.
River Gold uses mainly shrinkage stoping, a method designed for narrow vein deposits in which the orebody is mined from underneath, allowing broken ore to support the stope walls. River also expects to see a further reduction in costs when it has completed its $5 million shaft-sinking program at Eagle River. Hoisting ore will be less expensive than the current practice of hauling it up ramps.
Another junior success story is
Richmont is profiting from the addition of the Nugget Pond gold mine in Newfoundland. Nugget Pond, which had its first full year of operation in 1998, was Richmont’s lowest-cost producer at US$140 per oz.
In 1999, Richmont expects to produce 95,000 oz. gold at an average cash operating cost of US$190 per oz., and the company is on the lookout for another low-cost orebody to add to its portfolio.
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