Mineral economics – contents

1 Mineral Economics – An Introduction Philip Maxwell 1

Minerals and the World Economy

2 Some Foundations Philip Maxwell 11
3 Minerals and Development Philip Maxwell 21
4 Trade in Minerals Philip Maxwell 39

Minerals — Consumption, Production and Markets

5 Mineral Demand – The Theory in Practice Peter Howie 51
6 Mineral Supply – Exploration, Production, Processing and Philip Maxwell 67
Recycling
7 Mineral Markets, Prices and the Recent Performance of the Phillip Crowson 79
Minerals and Energy Sector

Mineral Finance and Investment

8 An Introduction to Mineral Finance Pietro Guj and Allan Trench 107
9 Mineral Project Evaluation – Financial Modelling and Discounted Pietro Guj 125
Cash Flow Analysis
10 Mineral Project Evaluation – Dealing with Uncertainty and Risk Pietro Guj 145

Minerals and Public Policy

11 Mineral Policy – An Introduction Philip Maxwell and Pietro Guj 179
12 Mineral Taxation and Royalties Frank Harman and Pietro Guj 191
13 Mining, Sustainability and Sustainable Development Roderick Eggert 215

M i n i n g a n d L o c a l C o mm u n i t i e s
14 Stakeholders, Local Communities and Regions Philip Maxwell 231
15 Minerals and Regional Development Philip Maxwell 237
16 Mining and Indigenous Populations Philip Maxwell 253
17 Occupational Communities – The Mineral Sector Workforce Philip Maxwell 269
Glossary of Terms 281
Subject Index 293
Name Index 301
 extended contents

Chapter 1  Mineral Economics – An Introduction Philip Maxwell

Definitions of economics and the economic way of thinking................................................................................................. 1
Economics and mineral economics................................................................................................................................................... 2
The focus of mineral economics......................................................................................................................................................... 4
Some key questions in mineral economics.................................................................................................................................... 6
The structure of this volume................................................................................................................................................................ 6
References................................................................................................................................................................................................... 7

Minerals and the World Economy

Chapter 2 Some Foundations Philip Maxwell
Mineral exploitation, production, distribution, consumption, trade and related economic concepts..................11
Measuring economic production and living standards...........................................................................................................13
Economic growth and development..............................................................................................................................................15
Periods of history and minerals.........................................................................................................................................................17
Mineral consumption and economic development..................................................................................................................17
Complicating factors with mineral production and consumption......................................................................................19
References.................................................................................................................................................................................................19

Chapter 3  Minerals and Development Philip Maxwell

The importance of mining in different nations...........................................................................................................................21
The ‘conventional’ view – minerals are a blessing......................................................................................................................22
An alternative view – minerals are a curse....................................................................................................................................23
Some background discussion.....................................................................................................................................................23
The resource curse thesis.............................................................................................................................................................27
Institutional and policy issues....................................................................................................................................................29
Some case studies..................................................................................................................................................................................31
The Australian experience............................................................................................................................................................31
The case of Chile..............................................................................................................................................................................34
The position of non-mineral economies.................................................................................................................................36
References.................................................................................................................................................................................................36

Chapter 4 Trade in Minerals Philip Maxwell

Why trade takes place...........................................................................................................................................................................39
Minerals and energy production and trade..................................................................................................................................40
Australian production and trade in minerals...............................................................................................................................42
Transport costs and the direction of minerals and energy trade..........................................................................................45
Minerals trade and exchange rates..................................................................................................................................................46
References.................................................................................................................................................................................................48

Minerals — Consumption,
Production and Markets
Chapter 5  Mineral Demand – The Theory in Practice Peter Howie
Introduction.............................................................................................................................................................................................51
The final-product demand curve and the level of consumption..........................................................................................52
Final-product demand and its determinants........................................................................................................................53
Mineral resources and derived demand........................................................................................................................................54
The mineral demand curve..........................................................................................................................................................54
Shifts in the mineral demand curve.........................................................................................................................................56
Elasticity of mineral demand.............................................................................................................................................................57
Own-price elasticity of mineral demand in the short run................................................................................................58
Income elasticity of mineral demand in the short run......................................................................................................61
Cross-price elasticity of mineral demand in the short run...............................................................................................61
Elasticity of mineral demand in the long run........................................................................................................................62
Conclusions..............................................................................................................................................................................................64
References.................................................................................................................................................................................................64

Chapter 6  Mineral Supply – Exploration, Production, Processing

and Recycling Philip Maxwell
Some introductory remarks...............................................................................................................................................................67
Short-run and long-run supply..................................................................................................................................................67
The mineral supply process.........................................................................................................................................................68
Supply curves....................................................................................................................................................................................69
Resources and reserves........................................................................................................................................................................69
Mineral supply – individual products, main products, co-products and by-products.................................................70
Key determinants of primary mineral supply..............................................................................................................................71
Individual and main products.....................................................................................................................................................71
By-products.......................................................................................................................................................................................74
Co-products.......................................................................................................................................................................................75
Secondary materials – the economics of recycling...................................................................................................................75
The supply of new scrap minerals.............................................................................................................................................76
Old scrap mineral supply..............................................................................................................................................................76
Total mineral supply..............................................................................................................................................................................76
References.................................................................................................................................................................................................78
Chapter 7  Mineral Markets, Prices and the Recent Performance of the
Minerals and Energy Sector Phillip Crowson
Market structure – competitive markets.......................................................................................................................................79
Market structure – imperfect markets............................................................................................................................................80
Departing from the competitive model..................................................................................................................................80
Alternative pricing arrangements.............................................................................................................................................83
The rise and fall of cartels....................................................................................................................................................................85
Producer pricing.....................................................................................................................................................................................88
Exchanges.................................................................................................................................................................................................91
The London Metal Exchange.......................................................................................................................................................92
Recent trends in mineral markets....................................................................................................................................................97
References.............................................................................................................................................................................................. 103

Mineral Finance and Investment

Chapter 8 An Introduction to Mineral Finance Pietro Guj and Allan Trench
Financial objectives and financial management..................................................................................................................... 108
The role of financial managers................................................................................................................................................ 109
Sources and application of funds.................................................................................................................................................. 109
General considerations.............................................................................................................................................................. 110
Main sources of funds................................................................................................................................................................. 110
Sources of equity................................................................................................................................................................................. 111
General considerations.............................................................................................................................................................. 111
Off-market sources of initial equity....................................................................................................................................... 111
On-market sources of equity.................................................................................................................................................... 112
Resource sector initial public offerings are generally small.......................................................................................... 113
Criteria for inclusion in a stock market index..................................................................................................................... 113
Innovative investment vehicles for the resources industry.......................................................................................... 114
Fiscal and policy incentives...................................................................................................................................................... 114
Joint venture farm-outs............................................................................................................................................................. 115
Specialty finance (royalty) companies.................................................................................................................................. 115
The cost of equity – balancing risk and return......................................................................................................................... 115
Sources of debt ................................................................................................................................................................................... 117
Some general considerations.................................................................................................................................................. 117
Long-term debt............................................................................................................................................................................. 117
Short-term debt............................................................................................................................................................................ 118
Hybrids between equity and debt................................................................................................................................................ 119
Project finance...................................................................................................................................................................................... 119
 Some introductory considerations........................................................................................................................................ 119
Risk underpinning........................................................................................................................................................................ 120
The financial structure of mining companies........................................................................................................................... 121
Cost of debt, financial leverage and financial risk............................................................................................................ 121
Financial structure of mining companies............................................................................................................................ 121
Conclusions........................................................................................................................................................................................... 122
References.............................................................................................................................................................................................. 123

Chapter 9  Mineral Project Evaluation – Financial Modelling and Discounted

Cash Flow Analysis Pietro Guj
What is it worth? – types and uses of financial valuations................................................................................................... 125
General issues................................................................................................................................................................................ 125
Market- and cost-based evaluations..................................................................................................................................... 126
Fundamental or technical evaluation................................................................................................................................... 127
Income-based valuations and discounted cash flow models............................................................................................. 127
The basic discounted cash flow model characteristics and structure....................................................................... 127
Constructing a simple discounted cash flow model of a mine in nominal dollars............................................... 130
Project valuations are at a point in time – discounting cash flows............................................................................ 132
Reconciling cash and financial accounting accrual figures in a discounted cash flow model......................... 133
Modelling debt and financial leverage................................................................................................................................. 134
Converting a discounted cash flow model from nominal to real dollars................................................................. 136
Modelling the preproduction period.................................................................................................................................... 136
Comparison of mutually exclusive projects with different lives........................................................................................ 140
Inherent weaknesses and common traps in discounted cash flow analysis................................................................. 141
Conclusions........................................................................................................................................................................................... 143
References.............................................................................................................................................................................................. 143

Chapter 10  Mineral Project Evaluation – Dealing with Uncertainty and Risk Pietro Guj
Introduction – beyond discounted cash flow/net present value analysis...................................................................... 146
Risk analysis – identifying and quantifying financial risk: expected value, sensitivity and
scenario analyses................................................................................................................................................................................. 146
Probabilistic financial models and Monte Carlo simulations.............................................................................................. 148
Attitudes to risk – from expected value to expected preference value (certainty equivalents)
and pricing of risky projects............................................................................................................................................................ 150
Understanding the nature of risk and risk-neutral expected returns........................................................................ 150
From risk-neutral to risk-averse investment decisions................................................................................................... 151
Risk preferences and the price of risky investment opportunities............................................................................. 152
Risk spreading through joint ventures........................................................................................................................................ 153
Bayesian (decision trees) and progressive risk and value analysis.................................................................................... 155
Size distribution of mineral deposits and the Zipf law................................................................................................... 159
From static discounted cash flow / net present value to dynamic real option valuations....................................... 160
A different logic............................................................................................................................................................................. 160
Types of real options in mining projects.............................................................................................................................. 160
The market has been effective at setting real option values........................................................................................ 161
Using the Black and Scholes formula to estimate the real option value of the Sally Malay project.............. 162
Modern asset pricing using commodity forward prices....................................................................................................... 163
Fundamental real option principles – value consistency, no-arbitrage and replicating portfolios............... 163
Commodities forward prices as certainty equivalents................................................................................................... 164
Using binomial lattices in valuing real options in practice........................................................................................... 166
Valuing an expansion option with the binomial lattice and binomial tree methods using the
‘risk-neutral’ probability.................................................................................................................................................................... 168
Binomial lattice method............................................................................................................................................................ 168
Binomial tree method................................................................................................................................................................. 168
Valuing tonnage-grade trade-offs................................................................................................................................................ 170

Valuing a farm-in/out sequential/compound option............................................................................................................ 171

Differences between real option value using binomial trees and ‘hybrid’ real option value
decision trees........................................................................................................................................................................................ 172
Strategic real option value considerations................................................................................................................................ 174
Conclusions........................................................................................................................................................................................... 174
References.............................................................................................................................................................................................. 175

Minerals and Public Policy

Chapter 11  Mineral Policy – An Introduction Philip Maxwell and Pietro Guj
The aims and practice of economic policy................................................................................................................................ 179
The context of mineral policy......................................................................................................................................................... 181
Mineral policy in practice................................................................................................................................................................. 183
The transition of mineral policy since 1950............................................................................................................................... 185
The post-1960 surge in public ownership........................................................................................................................... 185
The swing back to private ownership................................................................................................................................... 187
The rise of China........................................................................................................................................................................... 187
Some other current policy realities........................................................................................................................................ 188
Towards a competitive regulatory and fiscal regime for exploration and mining...................................................... 188
References.............................................................................................................................................................................................. 189

Chapter 12  Mineral Taxation and Royalties Frank Harman and Pietro Guj
Introduction.......................................................................................................................................................................................... 192
Minerals sector taxation............................................................................................................................................................. 192
Why are there special taxation and royalty regimes for the minerals sector?........................................................ 192
 Contents of this chapter............................................................................................................................................................ 192
A note on terminology............................................................................................................................................................... 193
Economic rent...................................................................................................................................................................................... 193
Economic rent and normal profit........................................................................................................................................... 193
Economic rent and scarcity....................................................................................................................................................... 194
Economic rent, scarcity and the minerals sector ............................................................................................................. 194
Pursuing economic rent............................................................................................................................................................. 195
Design principles for the taxation of mineral rents................................................................................................................ 196
Economic efficiency..................................................................................................................................................................... 196
Equity................................................................................................................................................................................................ 196
Administrative cost...................................................................................................................................................................... 197
Transparency.................................................................................................................................................................................. 197
Stability............................................................................................................................................................................................ 197
Taxes designed to capture economic rents........................................................................................................................ 197
Evaluating mineral taxation and royalty systems.................................................................................................................... 199
An initial assessment................................................................................................................................................................... 199
Problem areas................................................................................................................................................................................ 200
International experience with the taxation of mining rents............................................................................................... 201
Relevant constitutional powers in Australia.............................................................................................................................. 203
Ownership and control of mineral resources..................................................................................................................... 203
Powers to raise mineral taxes................................................................................................................................................... 203
Current mineral taxation regimes in Australia.......................................................................................................................... 204
Tax and royalty regimes in the Australian states, the Northern Territory and the Commonwealth............... 204
Other issues in the collection and use of economic rents in Australia..................................................................... 209
Commonwealth company income tax........................................................................................................................................ 211
Deductibility of exploration expenditures.......................................................................................................................... 211
Depreciation of capital expenditures.................................................................................................................................... 211
Other issues.................................................................................................................................................................................... 212
Mineral revenue policies for the future....................................................................................................................................... 213
Note on the literature................................................................................................................................................................. 213
References.............................................................................................................................................................................................. 213

Chapter 13  Mining, Sustainability and Sustainable Development Roderick Eggert

Introduction.......................................................................................................................................................................................... 215
Sustainability and sustainable development............................................................................................................................ 216
Mining and environmental sustainability.................................................................................................................................. 217
Mining and economic sustainability............................................................................................................................................ 218
Mining and social/cultural sustainability.................................................................................................................................... 219
Public policy – principles and concepts...................................................................................................................................... 220
Putting sustainability and sustainable development into practice in mining.............................................................. 222
Final thoughts...................................................................................................................................................................................... 224
Notes on the literature............................................................................................................................................................... 224
References.............................................................................................................................................................................................. 224
Appendix A: The Mining, Minerals and Sustainable Development project: nine key challenges.......................... 225
Appendix B: The International Council on Mining and Metals sustainable development framework................ 226
Appendix C: Summary findings of the Extractive Industries Review............................................................................... 226
Appendix D: Ten Principles of the Global Compact................................................................................................................ 227

M i n i n g a n d L o c a l C o mm u n i t i e s
Chapter 14 Stakeholders, Local Communities and Regions Philip Maxwell
Mining and its stakeholders............................................................................................................................................................ 231
Local communities and mines........................................................................................................................................................ 232
Occupational, residential and Indigenous communities............................................................................................... 233
Mining regions..................................................................................................................................................................................... 234
Australia’s regional framework and its mining regions.................................................................................................. 235
References.............................................................................................................................................................................................. 235

Chapter 15  Minerals and Regional Development Philip Maxwell

Some introductory considerations............................................................................................................................................... 237
Socio-economic indicators for local communities and regions.................................................................................. 237
Summary socio-economic measures for small areas...................................................................................................... 239
Economic impact assessment........................................................................................................................................................ 241
Economic (export) base analysis............................................................................................................................................. 242
Input-output analysis.................................................................................................................................................................. 243
Computable general equilibrium models........................................................................................................................... 247
Social impact assessment................................................................................................................................................................ 247
Origins and development......................................................................................................................................................... 247
Conducting a full social impact assessment....................................................................................................................... 248
Some examples of recent social impact assessments..................................................................................................... 248
References.............................................................................................................................................................................................. 250
Appendix – the structure of and solution to the input-output model............................................................................ 250

Chapter 16  Mining and Indigenous Populations Philip Maxwell

The world’s Indigenous populations............................................................................................................................................ 253
Mining and the Indigenous world................................................................................................................................................ 254
Indigenous Australia ......................................................................................................................................................................... 255
Some historical background.................................................................................................................................................... 255
Recent comparative data........................................................................................................................................................... 256
Indigenous Australia and mining.................................................................................................................................................. 259
An overview.................................................................................................................................................................................... 259
The Mabo case and more recent developments.............................................................................................................. 260
Indigenous employment policies........................................................................................................................................... 263
Looking to the future.................................................................................................................................................................. 263
References.............................................................................................................................................................................................. 263
Appendix – two case studies.......................................................................................................................................................... 265
Roebourne in the Pilbara........................................................................................................................................................... 265
The Argyle diamond mine and the East Kimberley region........................................................................................... 267

Chapter 17 Occupational Communities – The Mineral Sector Workforce Philip Maxwell

Introduction.......................................................................................................................................................................................... 269
Mining’s occupational community........................................................................................................................................ 269
Mining employment in developed and developing nations....................................................................................... 270
The formal mining sector.......................................................................................................................................................... 271
Artisanal and small-scale mining............................................................................................................................................ 271
Mineral sector employment in Australia..................................................................................................................................... 273
Historical trends............................................................................................................................................................................ 273
Employment, value added and wages in mining............................................................................................................. 273
Occupational and educational structure............................................................................................................................. 274
Location issues.............................................................................................................................................................................. 274
Important mineral sector workforce issues............................................................................................................................... 275
Gender imbalance........................................................................................................................................................................ 275
Maintaining a supply of well-trained professionals......................................................................................................... 275
The growth of fly-in, fly-out workforces............................................................................................................................... 277
Summary and conclusion................................................................................................................................................................ 279
References.............................................................................................................................................................................................. 279

Glossary of Terms 281

Subject Index 293

Name Index 301