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Lomas: Inventory and risk in mines

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Since the 1980s, production inventory shifted from being considered a hallmark of prudent management to an indication of waste, as factories and industrial plants have adopted strategies to lower costs and improve efficiency. The rationale is that inventory is expensive and ties up cash. Excess inventory also provides slack that steers managers to react to problems rather than develop ways to anticipate and avoid problems.

Mines, however, have not enthusiastically embraced inventory reduction programs. Unlike factories, mines produce their own input in the form or ore, using consumables like explosives and fuels and maintenance items. Mines are also often remote, where suppliers find it difficult to frequently deliver small quantities to minimize inventories at the mine.

However, the largest inventory in a mine is typically Work in Process, or WIP, meaning ore being mined or stored before it reaches the processing plant. Ironically, though WIP typically has the greatest volume, value, and cost of any kind of inventory in a mine, it often receives little attention from management.

Types of WIP in a mine

WIP can be considered more than piles of ore, since ore goes through several preparation steps within the mine. Underground mines best illustrate this, since underground mining involves more steps than surface mining. Workplaces must first be secured so that the surrounding rock is stable and supported. Electricity, water, ventilation, and sometimes compressed air must also be established before drilling can begin. Once the face or stope is drilled, the ore is blasted, loaded and hauled, and sometimes crushed underground, before being hoisted or trucked to the surface. Each of these steps absorbs cost as part of the process, but though those costs are difficult to assign.

Some mines have huge fixed costs while others are less burdened. A gold mine in wet, hot strata and with weak ground conditions may involve extensive ventilation, refrigeration, rock bolting, screening and shotcrete, whether any ore is produced or not. On the other extreme, a shallow room-and-pillar limestone mine producing the same tonnage in dry, stable rock may require only scaling loose rock to make the workplace safe for drilling and rely primarily on natural ventilation and leaving support pillars in place rather than replacing pillars with backfill.

Gold mining WIP

In the first case, the hot gold mine in bad ground, the costs in each stage of mining would look something like this:

Bolting and Shotcrete 17%

Drilling 5%

Blasting 3%

Mucking and Hauling 12%

Backfilling 15%

Everything Else 48%

In this case, the mine manager has little opportunity to build WIP inventory in cut-and-fill mining because ground support is integral to the mining cycle on both ends and is about 1/3 of the costs whether ore is produced or not. In other words, it’s difficult to get ahead on bolting or backfilling without breaking and moving ore. However, in this area, a mine like this may also have longhole stopes, which allow more drilling and blasting before backfilling, so stockpiling ore in longhole stopes to build flexibility in the system would be a better option.

“Everything Else” in this example includes staff costs, ventilation, pumping, refrigeration, and exploratory drilling and anything that doesn’t vary much with the production rate.

Limestone mine WIP

In the room and pillar example, the costs would be simpler:

Scaling 16%

Drilling 6%

Blasting 14%

Mucking and Hauling 27%

Everything Else 37%

The mine manager in this case can easily accumulate WIP. Room and pillar mining is usually a two-step process of driving headings horizontally and later taking out benches vertically in subsequent passes.

The bench mining phase is more productive, and requires little additional support, so leaving some benches in place allows the manager to rapidly step up production as needed.

Both mines in these examples have about the same production tonnage, but the cost per ton in the gold mine would be about five times that in the limestone mine, though the value of the gold ore might be about 10 times that of the limestone mine. Thus the value per ton of WIP inventory is higher in the gold mine, though its mining cost impact would be lower.

Thus WIP’s practicality, the cost, and the financial impact in an underground mine depends on the mining methods and the product’s end value. The limestone mine might be able to build more slack into the system, but excessive WIP could have a greater effect on the mine’s cost.

ROM inventory, the big problem

While managers may stash away enough partially-mined ore to get them through a rough month, or even to help them through prolonged operating difficulties, the largest WIP inventory cushion can be in ROM, which is Run of Mine stockpiles of mined ore on the surface. Unlike drilled headings and ore in stopes, surface stockpiles are obvious, frequently measured, and tracked by the accountants.

However, all that does not stop ROM inventories from getting out of hand. Some mines have years of stockpiles on the surface, representing years of production costs, which the mine has invested billions of dollars to accumulate. This may seem counterintuitive, but the problem with excessive WIP inventories is often that they are built bit by bit while business conditions change, and they are not managed strategically before they get too big to control.

A recent example of this was two iron ore mines in India, which had stockpiled 137 million tons of low-grade ore that had no domestic market due to falling prices, while India had a 30% export duty that prevented any of it from being exported. Eventually, the government rescinded the duty, and exports to China reduced the problem for the mines. Exports to China doubled last year but only absorbed a fourth of the stockpiles and resulted in Chinese steel imports flooding the Indian market, driving down prices, affecting their domestic steel producers.

The problem in India may have been economic distortions caused by government policy, but the same might be true in the USA. Ten years ago, a major gold mine had a stockpile inventory containing 5 million ounces and its long-term plan was to run the processing operations from stockpiles for 15 years after its mines ran out of ore.

Over the last decade, the value of the gold in that stockpile dropped $1 billion and then regained $3 billion in value due to the variation in gold price. Their long-term plan assumed a constant gold price over 15 years that is $300 an ounce less than today’s gold price, or $1.5 billion less than the stockpile’s current value.

Whatever the industry, it’s hard to justify the risk of holding several years’ worth of sales in WIP inventory for decades, when the change in the inventory value can vary over a billion dollars in a few months. All the cash used in production is tied up for decades generating no income, and future earnings after processing may be less than projected. In an extreme case, the stockpile could become worthless, as with the Indian iron ore stockpiles, resulting in a huge inventory write-down.

However, the idea behind building large ROM stockpiles in mines is sometimes traced to huge fixed costs in the mine that encourage high production rates, leading building a stockpile instead of attempting a plant expansion that the government may delay or not approve.

Other drawbacks of inventories

WIP inventories use up cash and distort cost reports, which are based on how much ore comes out of the mine, and not what is half-mined, drilled, or filling up a stope. ROM inventories tie up cash for years, and pose a financial risk when prices fall.

However, WIP and ROM inventories have additional problems. WIP can complicate grade, tonnage, production, and other operating ratios, which managers use to identify problems. Bolt usage, explosive consumption, labor hours, and other measures are tracked on a per-ton basis, and numbers are distorted if the tons are not moved when the resources are expended.

Stockpiles can cause even bigger problems. Sulfides can degrade or oxidize in stockpiles, so processes where sulfides in the ore provide fuel can cost more than expected as fuel has to be added to compensate for the lost sulfides. Some stockpiles can solidify enough that they cannot be easily loaded for transport. Volumes and grades in the stockpiles may vary from what is on the books, since both measurements are sometimes notoriously imperfect, and slight deviations from expectations may result in significantly less revenue.

Commodity values, taxes, and regulations all change, and the larger the stockpile, the greater the risk that a today’s ore may not be profitable 10 years from now. Chile’s Senate is considering a bill to finance the country’s pandemic-related costs by raising copper royalties to much as 75%, while the president-elect of Peru has vowed to increase taxes on copper mines. Nevada’s new tax on gold mines may double the current level, depending on the gold price.

Projections of inventory values made decades in advance using a constant value for the gold price, taxes, and inflation, and projections of a mine’s ore reserves, will vary as long as the stockpile is in place.

Stockbrokers will say that they can’t predict what the market will do in the short term, but that they know what the market will do in the long term. With mining, especially gold mining, the situation is the opposite. Gold prices have been somewhat stable over the past few years, but looking backward, gold prices have taken three substantial drops since the 1970s, and are likely to take three more substantial drops in the next 50 years. That does not make a strong case for building stockpiles lasting 15 years and expecting the economics to work out. 

Ed Lomas of Elko has a degree in mining engineering from the University of Idaho and an MBA from Harvard University. He has worked as a mine and plant engineer, underground mine superintendent, vice president of operations, and in strategic planning and business analysis.

Ed Lomas of Elko has a degree in mining engineering from the University of Idaho and an MBA from Harvard University. He has worked as a mine and plant engineer, underground mine superintendent, vice president of operations, and in strategic planning and business analysis.

"Whatever the industry, it’s hard to justify the risk of holding several years’ worth of sales in WIP inventory for decades, when the change in the inventory value can vary over a billion dollars in a few months."

--Ed Lomas 

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