Mining, Risk, and Profit
On November 2, 2007 the US House passed a new mining law that mandates a 4% gross royalty on existing mines and an 8% royalty on future mines on public lands. The royalty, if imposed, represents expropriation over and above the corporate income tax mining companies presently have to pay. It also represents the common view that the proceeds from mining — or any other endeavor for that matter — if carried out on public lands are the property of the general population.
In other words if a miner goes to the effort of looking for, finding, developing, and producing copper in Utah, everyone in Florida is entitled to the fruits of his labor just because people in Florida happen to live within a political area that also encompasses the mine. This argument sounds awfully like slavery to me, although it represents a belief system that is generally left unquestioned. It is a strong emotional argument largely emanating from the government proposing the bill, which would undoubtedly benefit politically by dispensing the proceeds of the royalty.
The problem with the argument is that it discounts the benefit that Americans and indeed all humans are receiving from mining operations and the risk undertaken by the mining industry that allowed for the benefit. The royalty is more than the average return on invested capital for mining and will effectively kill mining in the United States because exploration for new mines will be conducted elsewhere in the world where the climate is less onerous. Adding 8% to the cost of copper will only hurt the consumers of copper who, as it turns out, include those same folks in Florida.
AN OVERVIEW OF MINERAL EXPLORATION AND MINE DEVELOPMENT
Metal production and use is not new to modern times. Civilizations have been measured by the metals that they produced and used (e.g., the Iron Age). After more than five thousand years of recorded mining and metal use, prospectors have scoured the earth and discovered practically all exposed concentrations of metal in an effort to fill demand. Today, finding a site to evaluate for mineral potential means having to go to some of the remotest areas of the planet, or using more advanced technology to evaluate an area for unexposed mineralization.
Over the last 40 years, in response to rising demand and a dearth of easy-to-find mineral deposits, various technologies have been developed to guide the geologist in exploring areas where mineralization is not exposed. This includes the science of geology itself, where a wealth of information has evolved from the study of mineral deposits and how they form. This massive investment in knowledge now allows geologists to predict where mineralization might occur beneath the surface.
Mineral exploration is perhaps the riskiest of business ventures, based simply on the complexities of nature and the rarity of zones of concentrated metal. Mineral value cannot be quantified until core samples are taken through a process called drilling, which enables mineral content to be evaluated in three dimensions. Today geologists spend their efforts interpreting layers of expensively acquired scientific data and geologic observations, evaluating hundreds of potential targets just to find an area prospective enough to risk the expense of drilling. Several studies conducted over the past 30 years indicate that for every 500 to 1,000 mineral showings drilled, one mineral deposit with sufficient value to mine is discovered. This means that most mineral exploration companies never find a mine with the venture capital money they raise and spend.
The risk does not end with discovery, however. Subsequent to the identification of a mineral resource many other factors are considered. A feasibility study is conducted which determines the costs of construction, including roads, power and water supply. Often the metallurgy or the ability to extract the metal from the rock render a mineral deposit uneconomic to mine due to the chemical complexity of the surrounding rock. There are the costs of mining, milling, and refining the ore and transporting the metal to the consumer. There may be a cost in removing rock that is barren in order to access the mineral-bearing rock. These costs often depend on the remoteness of the proposed mine and the access to preexisting infrastructure.
If the deposit still appears to be economic to mine, political risks and environmental costs need to be considered. Many well-financed NGO's are committed to stopping mining development and become active opponents to a proposed mine. Often a significant investment in public relations is required to combat negative public opinion. Environmental regulations require that companies spend large amounts of money in the feasibility stage to determine environmental impact and to put significant money aside to rehabilitate the mine when production ceases. Finally metal prices need to be considered and predicted over the life of the proposed mine. Many mines have been rendered uneconomic by an unforeseen change in the price of metals.
Should the proposed mine pass these obstacles, the money to undertake the venture needs to be raised from investors. Few of the largest mining companies in the world have the funds to construct a mine and, as a result, they finance with large banks.
As an example, the Antamina copper-zinc mine in Peru was recently put into production by a consortium of companies at cost of US$2.2 billion, US$1.3 billion of which was financed by loans. This money went towards construction costs as well as new infrastructure such as a port facility, 76 kilometers of new road, a new pipeline, 58 kilometers of new power line, and a switching station. Costs also included environmental studies required to acquire over 300 government permits. The mine is currently in operation and has a labor force of over 1,400 people, only 28 of which are foreign staff.
Estimates of the time needed to pay back the entire investment vary, but go up to 10 years of the projected 19-year mine life. These estimates depend on metal prices and assume that a hurricane won't destroy any infrastructure and the government doesn't decide to nationalize the mine. In the meantime, the new infrastructure and jobs benefits many Peruvians in immeasurable ways, including increased access to electricity, healthcare, education, and trade. The infrastructure will also stimulate further mineral exploration and possible mining development in the area and may make other business ventures viable that might otherwise have been uneconomic. Sentiments in the countries of origin of the mining companies, as well as their shareholders, demand that the companies invest in the local communities, in the form of humanitarian aid including the construction of schools and drilling of water wells.
Over the last 25 years mining companies have had profits of about 5% on average, which are net of costs and payments on loans. As with Antamina, these profits are really returns on large investments to put the mines in production, or debts the companies have not yet been recovered. A profit margin of 5% means that to get the metal out of the ground it costs on average 95% of the value of the metal produced. By far the largest shares of the costs are labor, power, and services. The goods and services needed by a new mine are immense in scale and encompass the labor of mechanics, computer technicians, drivers, engineers, and cooks, all representing new economies created by the mine.
It should be noted that once the debts are repaid the profit is subject to the corporate income tax. BHP Billiton Ltd., one of the largest mining companies in the world operating mines in Chile, paid US$1.5 billion in taxes to the Chilean government over the past 15 years. Any profits that remain, the owners of the company keep. In 2001 the company paid US$751 million in dividends to the owners, 298,000 shareholders, including pension funds that represent innumerable people.
Despite the huge investment required and the financial risk it bears, the mining industry is miniscule compared to the industries that depend upon the metal that mining produces. The copper from the Antamina mine may be turned into wiring for electric motors, copper pipe for water or into the circuit board of a personal computer. In each of these cases the copper is sold at many times its value in raw form.
The term sustainability is often bandied about in intellectual discussion, but with respect to mining, it never accounts for the fact that the cost of finding, mining, and refining metal dictates that it is cheaper to recycle metal than start from scratch. When one considers that practically all the copper ever mined is still in use, mining can be considered infinitely sustainable. People with antidevelopment notions should also consider that over 50% of the copper produced today goes to developing nations, owing to the fact that rich, already-developed countries recycle much of what they need; nearly half of the copper consumed each year in the United States is recycled.
Preventing a mine from being developed in Chile may mean that people in China don't get copper pipes to transport clean drinking water.
MINING IN THE UNITED STATES
US legislators are trying to implement this new and very onerous royalty by claiming that American aren't receiving enough benefit from the production of metals on public lands in the United States. The royalty proposes to rectify this manufactured grievance by exacting by force every American's share of the proceeds of mining operations on their behalf. Presumably the intended result is that their government will have more money to spend (hardly a positive outcome) but the net effect to the American citizen can hardly be considered positive. If copper and other metals are to be produced without loss, their prices will have to be 8% higher to offset the royalty. While most Americans will never see the money the government takes they will have to bear the cost of the higher metal prices that result. Since prospectors and miners will go elsewhere, the greatest and perhaps intended effect of the royalty will be to render prospecting and mining losing activities in the United States.
All the mines that are easy to find have been found. New mines will be increasingly expensive and difficult to locate. If the United States Senate passes this mining royalty, it is highly unlikely that anyone will want to undertake the risk to find more mines in the United States for the benefit of humanity. Making prospecting in the United States unprofitable reduces the portion of the earth prospectors have to work with, thereby raising the costs of living for all people, regardless of where they live. The only beneficiaries of such a royalty would be the state and the privileged groups to whom it decides to dispense the proceeds.
Bilodeau, M.L. and Mackenzie,B.W., 1977, The drilling investment decision in mineral exploration, In: Application of Computer Methods in the Mineral Industry, Society of Mining Engineers of the American Institute of Mining, Metallurgical and Petroleum Engineers. 14, p. 932-949.
Henriquez, L.N. and MacKenzie,B.W., 1981, Analisis economico de la exploracion minera con referencia a Canada y Chile, Minerales, 36; 155, p.3-23.
Mackenzie, B.W., 1975, Economic characteristics of mineral investment in Canada, In: What does mining mean to Canada, Canadian Mining and Metallurgical Bulletin 68, p. 761.
—— 1987, Looking for the improbable needle in a haystack; the economics of base metal exploration in Canada, In: Selected readings in mineral economics, in: Anderson, F.J., (ed.), Selected readings in mineral economics, Pergamon Press, NY, p. 36-61.
—— 1987, Mineral exploration productivity; focusing to restore profitability, in: Anderson, F.J., (ed.), Selected readings in mineral economics, Pergamon Press, NY, p. 79-101.
—— 1994, Evaluating and controlling geological risk, In: Jones, H. (ed.) Managing Risk, Australasian Institute of Mining and Metallurgy. 6/94, p. 47-55.
McDonald, R.J., 2000, The economic performance of an "old" industry: mineral extraction and processing, Australasian Institute of Mining and Metallurgy, Sydney.
 Dr. MacKenzie, formally of the Department of Geological Sciences and Geological Engineering at Queens University has published the most important papers on the odds of exploration success.
 Datastream study, 2003. This study measured return on capital over 25 years for the mining sector which resulted in the figure of 5.2%. This compares to 18% for waste disposal companies and 16% for both software and tobacco companies. A study by Rob McDonald, managing director of NM Rothschilde and Sons (Australia) Limited in 2000 determined that, over the roughly the same 25-year period, mining companies generated an average compound rate of return to shareholders of 5%.
 The total number of shareholders is not reflected in this figure. The figure of 298,000 includes institutional investors such as union pension plans and mutual funds representing huge numbers of people. Taken from BHP Billiton's website.
 The proportion of world copper production consumed by the developing world is projected to rise sharply, most notably in China, which currently consumes roughly 20% of copper produced and has surpassed the United States. Taken from the Copper Development Association's website, Copper.org.