Risk Assessment changing with the times

Cape Town, South Africa — Miners and lenders have a long-standing and, for the most part, mutually beneficial relationship. But according to lawyer Nabil Khodadad, a partner at New York City-based Chadbourne & Parke — a firm that has been involved in many deals between lenders and mining companies — that relationship is changing.

Speaking at the recent Mining Indaba 2006 conference here in Cape Town, Khodadad said lenders are revising the tools they use to assess the risk of prospective projects in an effort to keep pace with the times.

The risks that lenders have long pored over — reserve risk, completion risk and technical risk — are still essential, Khodadad said.

If there aren’t strong indicators for an economic deposit, the company won’t be able to secure a loan. If a company doesn’t show that it has reliable contractors, a contingency plan and reserve funds in case construction goes past the completion date and over budget, lenders will be wary. And on the technical side, lenders will ask if the planned technology has been used on a commercial scale before.

However, while these three fundamentals remain prime considerations, lenders are beginning to examine other types of risk more closely. As companies expand into new frontiers, Khodadad said, political, legal, social and environmental risks are becoming higher priorities for lenders.

Rising energy costs are pushing supply risk assessment up the priority chart, Khodadad said. Most lenders will want a long-term purchase agreement to secure power at stable prices — especially with commodities like aluminum, where up to 42% of total costs associated with the product come from energy use.

Then there’s market-demand risk. Lenders want to know that companies have buyers, and that their products can be actively traded. Offtake agreements are a big asset to companies looking for money, he said, citing Aber Diamond’s (ABZ-T, ABER-Q) situation in the early ’90s as an example.

“Aber got $230 million in financing for its stake in Diavik,” he said. “That was the largest amount at the time lent to a Canadian company. But they got it because they had an agreement from Tiffany’s to buy fifty million dollars’ worth of diamonds (per year). Without that in place, lenders wouldn’t have approved financing.”

Associated with market-demand risk is price risk. Khodadad said lenders try to predict the price of the product in two to three year’s time — when the mine in question will be in operation. While hedging is always an option to mitigate price risk, Khodadad confirmed that the strategy is growing less popular, as investors are more willing to take on price risk. Companies are engaged in the lowest level of hedging since the 1980s, he said.

Legal risk

Lenders are also assessing legal risk more closely. As companies head into countries that often operate by unclear rules, lenders are questioning whether negotiated contracts can actually be enforced. Khodadad said companies must prove they have reliable forums — such as arbitration — to resolve issues.

Connected to this are the mining codes of individual countries. As newer codes emerge, companies must be sure that they thoroughly understand them — something Khodadad said is getting easier. He credited Chile with setting the bar regarding transparency and dependability in mining codes, adding that many other Latin American countries have followed suit. The trend is carrying over into Africa as well, he said.

With different mining codes come different tax structures — and lenders want to know if a company will have enough cash flow to pay down its debt after taxes.

Khodadad singled out Ghana, Chile and Mozambique as countries that have positive tax structures that instill confidence in lenders.

The government of Ghana actively uses tax breaks to help mobilize investment; in Chile, a company can stabilize taxes for a 10-year period; and in Mozambique, tax privileges are granted to companies that operate in certain zones.

While working out a foreign country’s tax structure can be a challenge, companies may face much worse in some developing countries. Land expropriation is a risk in some parts of the world, and Khodadad said companies need to foster strong relationships with both private and internationally recognized governmental organizations that specialize in mitigating such risk.

Sustainable development

But the two risks Khodadad said lenders are paying increasing attention to are social and environmental risk — both of which can be encapsulated by a company’s approach to sustainable development.

“The industry is now talking about fairness, and people and consultation — things lenders weren’t hearing in the ’90s,” he said.

While sustainable development was on the lips of most of the presenters at Indaba, Khodadad drove the point home further. Because lenders look at social and environmental issues more than ever, he said, they are less likely to lend to companies whose commitments to these issues are in question.

Khodadad illustrated the attitude he believes lenders are looking for in companies with a quote from the World Commission on Environment and Development’s 1987 Brundtland report:

“Development that meets the needs of the present without endangering future needs.”

While Khodadad conceded that the nature of mining precludes the industry from literally meeting the future needs of others, he said the mining community should take the words to mean that their projects should ensure long-term benefits to the community.