dealing with mining projects uncertainties in …...mohammed v university, rabat, morocco anas bahi...

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International Journal of Civil Engineering and Technology (IJCIET)

Volume 9, Issue 6, June 2018, pp. 497–506, Article ID: IJCIET_09_06_057

Available online at http://www.iaeme.com/ijciet/issues.asp?JType=IJCIET&VType=9&IType=6

ISSN Print: 0976-6308 and ISSN Online: 0976-6316

© IAEME Publication Scopus Indexed

DEALING WITH MINING PROJECTS

UNCERTAINTIES IN MOROCCO: A REAL

OPTIONS PROFITABILITY EVALUATION

Jihane GHARIB

MOAD-SCM Laboratory, Mohamadia Engineering School,

Mohammed V University, Rabat, Morocco

Anas BAHI

L3GIE Laboratory, Mohamadia Engineering School,


Ahmed AKHSSAS

L3GIE Laboratory, Mohamadia Engineering School,


ABSTRACT

Reopening a lead mine in Morocco is an investment project with multiple sources

of uncertainties and high risks, however it represents a great potential of profitability

expansion and of financial growth. Thus, this project requires a clear overview of the

lead reserve of the mine but also an evaluation method capable of assessing it

particularities. In this paper, the mine of Zaida is studied by defining its geological

and mineral aspects as a first step to reopen the mine and to start the extraction of the

lead, before examining the nature of investing in mining projects and the categories of

the uncertainties related to this type of projects. Furthermore, the methodology of the

real options as a project valuation tool is introduced and applied to this study in order

to evaluate this project’s profitability and to reassure investors concerning the

profitability of this mining project.

Key words: Mining Project, Mine Uncertainties, Project’s Profitability, Real Options,

Project’s. Evaluation.

Cite this Article: Jihane GHARIB, Anas BAHI and Ahmed AKHSSAS, Dealing with

Mining Projects Uncertainties in Morocco: A Real Options Profitability Evaluation,

International Journal of Civil Engineering and Technology, 9(6), 2018, pp. 497–506.

http://www.iaeme.com/IJCIET/issues.asp?JType=IJCIET&VType=9&IType=6

1. INTRODUCTION

The use of appropriate project evaluation techniques is more important in the mining industry

than the other industries. This is because the mining industry is extremely capital intensive,

require many years of production period before a positive cash flow commences, and requires

Dealing with Mining Projects Uncertainties in Morocco: A Real Options Profitability Evaluation


longer project life compared to other industries. The major challenge for a valuation technique

is to be able to consider the project risk, effect of time and management of flexibility in the

valuation [1]. The risk associated with a mining project comes from the uncertainties involved

in the industry. Uncertainties can be classified as internal and external sources [2].

Commodity price is an important risk factor for mining companies, as price volatility is a key

parameter for mining project evaluation and investment decision making [3].

In this paper, the project is implemented by a Moroccan company specialized in the

exploitation of mines and quarries. It started the reopening of the lead deposit of Zaida. The

project is today ready to start production, and the risks related to the reserves and the

feasibility are completely reduced because this mine is a brown one and the only reason of its

closing is the dropping of the Lead price in the mid- eighties. The company has an immediate

need of 100 million dirhams to mount the existing plant and start the first production phase

with a capacity of 600 kilotons per year, to acquire and mount the new equipment to increase

the capacity to 1.2 million tons per year; and to finance the starting cash flow.

Nowadays, the lead market displays a good dynamics of growth, due to ascending demand

and insufficient offer. The price of lead today is currently promising and encouraging to

reopen this mine. As a consequence, the company mandated studies to seek financial advisory

and assistance in raising the necessary funds to start the production of the lead in Zaida.

This article starts with a description of the area of this mine, by presenting its geological

location and its lead potential in order to display its reserves level. Moreover, a discussion

about uncertainties in the mining industries is established to overcome this issue and to

resolve one major source of uncertainty for this project’s profitability evaluation. Finally, an

application is done using the mine’s data and the real options methodology to assess its

profitability potential for its reopening and the starting of the lead extraction and sale.

2. DESCRIPTION OF THE STUDY AREA

2.1. Identification of the Mine

Zaida is an open pit deposit discovered in 1958. The ONHYM formerly known as BRPM

(The Moroccan mining research and participation bureau) (the equivalent of the USGS) has

conducted; exploration studies and technical works on an area of 35 Km2, development

studies and built a pilot production plant during the period 1958-1971.

In 1971, BRPM went into a joint venture with other investors to create company called

SODIM. SODIM main goal was to extract, process and commercialize the Zaida lead. This

deposit was cited, as a Red-Bed or Sandstone deposit, in most of the highly respected

international geological records. In 1984-85 and due to the drastic fall of lead market prices,

SODIM decided to close the mine of Zaida.

Zaida lead deposit is located on the Moulouya river at the cross section of road N °13

30km NW of the town of Midelt and 150Km SSE of the town of Meknes. The deposit has an

area of about 35 Km2 and is laid on both sides of the river [4].

Jihane GHARIB, Anas BAHI and Ahmed AKHSSAS


Figure 1 Location and access to the Zaida mining domain

2.2. Geological Context

The Zaida deposit is located on the Moulouya basin within the western part of the high

plateau. It is a basin surrounded by the high and the middle Atlas. The Hercynian substratum

is morphologically composed of two boutonnieres (Fig. 2): Boumia in the SW and Aouli in

the East. The deposit is hosted in the detrital Arkose formations Triasic layers.

Figure 2 Location of mining area on the geological map of Morocco 1/1000000

It is mainly present in the Paleo channels and spreads in the SW direction all the way to

Boumia region. The Zaida mineralization is composed by 70% Cerusite and 30% Galena.

Barite is incidentally present to reach 9% in some of the panels.



Figure 3 Diagrammatic section showing the position of the mineralization in the buttonhole of the

High Moulouya and its coverage, according to Emberger (1965b), (approximate scale).

2.3. Lead Potential

The Zaida lead deposit is listed internationally as Sandstone or Red-Bed type deposit. It has,

for instance, been listed in the Mineral Deposit Models, USGS Bulletin 1963 and 1987

editions.

Keeping in mind that proved reserves are higher than 9 million tons, the correlation between

the deposits proportions of this kind present on the globe and the reserves in millions of tons

reveals that Zaida deposit is within the top 30% category.

It is also true for the correlation between the deposits proportions of this type and their lead

content. In other words, for an average lead content of 3%, the Zaida deposit is within the 30%

range.

Numerous studies were conducted during the 1965-1985 period and provided the

following;

Core drillings; 30500m

Destructive drillings; 170000m

Geological maps on a scale range; 1/50000 to 1/200

Geochemical studies;

Geophysics studies; Electric and gravimetric methods.

The studies cited earlier allowed the illustration of the proved reserves mounting to 18

million tons averaging 3% lead content.

2.4. Extraction Method

Zaida will be mined as an open pit mine. The Arkose thickness averages between 2m to 7m, 0

to 50m of overburden. The overburden to the Ore ratio averages around 2.55. This Open-pit

mine will involve:

Removal of overburden will be carried out by:

- Blasting,

- Excavators

Loading will be carried out by Backhoe loaders

32 to 40-ton capacity trucks will carry out transporting the broken ore to a mill for processing.



We intend, however, to initiate few changes. This will be carried out in order to improve

the quality of the concentrate produced by the newly installed plant. All of which will be done

within the environment protection set of rules.

The processing plant will be built according to the following flowsheet:

The crushing phase is designed in three steps. The ore will be fed at a size of 0 to 1000 mm.

The product will come down to a n ore of a size of 10 mm.

The ore will be grinded to a size of less than 290 micrometer

A silo of a capacity of 10000 tons will be installed between the crushing and the ball mills.

The floatation phase is schematized with a conditioner and floatation cells. The cells will

insure the roughening and the backwashing.

The final product will go through thickening and consequently a filtering phase.

The tailings will be pumped out straight to the tailings dam.

Figure 4 Illustration of the processing plan of the lead extraction

3. PROJECT’S VALUATION METHOD

3.1. Particularities of Investment in Mining

When managers estimate what it costs to invest in a given project and what its benefits will be

in the future, they are coping with uncertainty. The uncertainty arises from different sources,

depending on the type of investment being considered, as well as the circumstances and the

industry in which it is operating. Uncertainty can result from economic factors, market

conditions, taxes, and interest rates, among many other sources.

Mining projects are complex businesses that demand a constant assessment of risk. This is

because the value of a mine project is influenced by many underlying economic and physical

uncertainties, such as metal prices, ore grades, costs, schedules and environmental issues [5].

The main sources of uncertainty arising at the beginning of a mine project can be

categorized into three groups:

Exploration uncertainties: such as geologic uncertainty, data collection, interpretation,

modeling, deposit classification, reporting and so forth.



Engineering uncertainties include bench heights determination, planned grade control,

minimum stopping widths, choice of stopping method, dilution factors, geotechnical and

hydrological parameters, mining recovery factors and metallurgical recovery.

Economic uncertainties represent one of the most crucial sources of uncertainty and, if left

unchecked, may have a critical impact on the evaluation of the mining project. The fluctuation

of commodity prices and the exchange rate are, singularly and combined, the most important

external uncertainties facing mining companies.

According to the results of a Canadian Mineral Economics Society survey, where

respondents were asked to rank a list of mining project risks, the highest risk comes from

mineral reserves and ore grade, then political, social and environmental, metal price,

profitability/operating cost, location, capital cost, management and so on [6]. Blais et al. [7]

mentions that the mining industry has been increasingly focusing on using a sophisticated

approach to define the effect of risk on the project value and mine policy. Moel and Tufano

[8] carried out an empirical study to define the main reasons for annual mine opening and

closing decisions using 285 developed North American gold mines in the period 1988–1997.

The decisions on mine closures are affected by the price and volatility of gold, operating cost,

proxies for closing costs and size of the reserves. It is documented that the mine opening and

closing flexibility is used frequently and the project evaluation technique needs to capture

these flexibilities. Lilford and Minnitt [9] studied project valuation methodologies for mineral

deposits. At the end of the study, it was concluded that the selection of the valuation

methodology depends on the ability to correctly interpret all of the available information and

fundamental factors (commodity prices, exchange rate, technical information, economic

information, comparative transactions, uncertainty risk) required for each valuation

methodology in order to guide selection process [2].

These sources of uncertainty influence future cash flows. Thus, managers need to assess

the uncertainty associated with a project’s cash flows in order to select value-adding projects.

One of the challenges in evaluating an investment opportunity is capturing the flexibility

options that a project offers.

3.2. Proposed Valuation Method: Real Options

3.2.1. Presentation and Definition

Real option’s definition is the right but not the obligation to make favorable future choices

regarding real asset investments. The methodology of real options is still unknown by many

project managers, yet this approach is derived from the financial options. Real Options

Theory is based on the analogy between investment opportunities and financial options. The

literature in the area is relatively recent, almost four decades.

The Real Options methodology was developed, at least partly, as a response to the

inadequacy of traditional methods for the evaluation of capital budgeting decisions under

uncertainty, namely Net Present Value and Decision Analysis. Since its inception, the Real

Options methodology has gained acceptance among the finance community, and has been

applied to a variety of capital investment decisions.

3.2.2. Historical Review

Options valuation was introduced when Black and Scholes [10] established a mathematical

derivative model known as the Black-Scholes option pricing model back in 1973. Based on

their model in 1977, Myers [11] used, for the first time, the term "Real Options (RO)"

observing that corporate investment opportunities can be viewed as call options on real assets,

pointing out the similarities between the financial options and the real options.



In 1985, Brennan and Schwartz [12] applied option pricing techniques to the evaluation of

irreversible natural resource investments. They studied the problem of how to estimate the

value of a copper mining project with a high-risk cash-flow. In their research, they

constructed a financing portfolio including short-term assets of futures contracts, and long-

term assets of mineral resources, and then obtained a partial differential equation of copper

values.

The energy sector, since 1970, has suffered market, regulatory and technological changes.

In this new context traditional capital budgeting methods are no longer sufficient to properly

evaluate investments in this sector. This change opened the way to the application of the real

options theory. An increase on the interest and application of the real options theory to the

energy sector decision making has been noticed during the last years, as seen in the presented

literature review, this theory has been used to all sectors in the energy. This increase reveals

that the interested parties in the energy sector now understand the limitations of the traditional

techniques, given the potential of the real options theory. The renewable energy sector is no

exception and a few studies using the real options theory appeared recently in the literature,

although this particular literature is still limited.

Despite extensive research in investments under uncertainty using real options in natural

resources investments, only a limited literature addresses mining project evaluations using

real options under uncertainty [13].

4. RESULTS AND DISCUSSION

4.1. Financial Market and Context

The world production of lead was of 5.3 million tones in 2013, with a progression of 6.4%

over the previous year. The production of lead depends from the international demand, mainly

China, 1st producer and consumer of the metal in the world, but also by United States, Europe

and the emerging countries. The main market is the automotive industry, which is growing at

an annual rate of over 8%.

On a long-term view, the growing demand of lead is at 2.8% since 1977, with an increase

at 3.9% since 2000. This trend must continue in the future.

Until 2025, Deutsche Bank expects an annual demand of 15 millions of tons of refined

lead growing at an annual rate of 2.5%. That implies an annual growth of 3.8 to 4.8 million

tons per year in 10 nearly years.

Deutsch Bank expects an indicative price of lead of $2095 per ton in 2016 and at more

long term reaching $2400 per ton in 2018.

Figure 5 Lead 10 years Historical Price Chart.



4.2. Review of the Investment

Given the history of the mine of Zaida, plus the updated geological and engineering studies

and based on the clear Lead potential of this mine, it had therefore initiated an investment of

about $6 Million. This amount was invested mainly towards the following but not only:

The acquisition of the mining licenses;

The Geological, Engineering and Environmental studies.

The Acquisition of the equipment required to building the processing plant.

The plant of Zaida still required an additional investment of 97.5 million dirhams for the

following reasons:

Mounting the exiting equipment for 15 million dirhams

Acquiring and mounting the new equipment to reach the full capacity of processing 1.2

million tons of mine ore per year, for 82.5 million dirhams

We assume this additional investment of 97.5 million dirhams to be made in the first

quarter of 2018. The total amount that has been invested to reopen, explore and launch

production of this mine is: 103,5 million dirhams.

The profitability analysis was done over 10 years of mine production, considering the lead

price as the most important source of uncertainty with a price volatility of 23.7% and a risk-

free rate of 5%.

4.3. Results & Analysis

The valuation of the mine is conducted using the real options methodology, by adopting a

combination of options for a better valuation and optimization use of flexibility inherent in

them. The managers have the possibility to choose between 3 different options thus strategies

as previously established and explained in details in previous work [14]:

To EXPAND the production of the mine of 40% by investing 40 million Dirhams,

To keep the option open and wait and see future changes,

To Contract 60% its production to save 50 million Dirhams.

The calculations of the options values have been done using a binomial tree for this

application [15]. Figure 6 represents the final version and the results obtained using this

methodology.

Numerical results of the real options valuation of the mine project in Zaida, using the

option to choose, provided a value of 132 million. MAD. The initial investment of the project

was 103.5 million. MAD. The difference of 28 million. MAD is the substantial added-value to

the project by real options which management can take into consideration in making the

project decisions. Figure 6 shows the strategic choices this project’s managers would make at

different points during the option life.

It also appears that, at the end of the 10 year, the mine is highly productive and the

expansion of its production is recommended given the fact that the option’s value at this node

is more than 1510 million. MAD.



Figure 6 Binomial tree of the project

Moreover, this study was conducted only on a short period of time (10 years) which is

obviously not enough to explore the total capacity of the mine, but only to provide a glimpse

of the project’s profitability for investors and to encourage mining engineers to develop more

competitive technologies to expand the extraction rates of this mine as recommended earlier.

5. CONCLUSIONS

This paper proves that reopening the Zaida mine in Morocco is a profitable project for the

investors who conducted a series of geological and mining studies in order to assess this

project’s potential. In fact, the reserves level determined by the mineral engineers are very

promising given the lead’s upscaling prices for the next years.

For this study, dealing with the mining project uncertainties came up to concentrating on

the high volatility risk one: the ore price. To properly visualize the development of the mine’s

profitability, the real options methodology was introduced as a strategic tool capable of

integrating the risk factor in order to proactively manage the future years’ flexibilities and

take advantage of the market’s changes to help the growth of the mine’s production and

maximize the gains. Thus, the project turned out to be highly profitable and promising.

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The real options had proven once more their powerful effect over handling investment

projects uncertainties and proactively managing future changes. This methodology should be

applied more often in the mining industry and the infrastructures projects overall.

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[4] Information Memorandum-Zaida lead deposit, March 2016.

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[7] Blais, V. and Poulin, R. (2004) ‘Stochastic pricing of real options’, 13th Annual

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[13] Haque, M.A. et al 2016. Evaluation of A Mining Project Under The Joint Effect of

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October 11-13 2017, Lisbon, Portugal.

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