Exploration is the lifeblood of the mining industry. Junior mining companies, staffed by geologists and finance professionals, search for new deposits to bring them to a stage of development that make them targets for acquisition by major commodities producers. To do so they need to attract investors willing to bet on their projects and management teams. With commodity prices remaining low for much of 2015, Peru’s junior explorers were faced with tough choices.
In the wake of the global financial crisis, gold prices soared as buyers sought to hedge against political risk and inflation. From around $500 per oz at the beginning of 2006, gold peaked at $1921 per oz in September 2011. Dozens of exploration firms entered Peru, attracted by the metals-rich geology of the Andes Mountains and a favourable investment environment. In 2014 Behr Doblear rated Peru the seventh-most-attractive country for mining investment out of 25. The Fraser Institute Survey of Mining Companies 2014 ranked the country the second-most-attractive for investment in Latin America after Chile. Although social issues around mining projects in certain regions persist, the government has developed a friendly regulatory environment, there is a good stock of trained professionals and mining services firms, and the country has a strong mining tradition. Peru seemed the ideal market for companies’ risk capital. In 2011 the country accounted for some 4% of a record $18.2bn in global exploration spending, according to Metal Economics Group.
Commodities prices have dropped steadily over the past four years. Gold prices had stabilised at around $1100 per oz by the beginning of 2016, but the 40% fall appears modest when compared to the knock-on effects on company valuations. The Market Vectors Junior Gold Miner Index, which tracks junior miners on the New York Stock Exchange, plummeted from $171 to $21 over the same period, – 88% – a fall from which investor confidence may take time to recover. Exploration across the globe slowed as juniors went into maintenance mode to keep costs down, and with share prices down, returning to the market for funding represents a dilution for existing shareholders. Global exploration is set to decrease to $10bn in 2015, according to SNL Metals & Mining.
Lost In The Andes
Even in this depressed environment, the market remains quite complex. It is important to divide exploration into brownfield and greenfield projects. The former is normally undertaken by producing mines, or those in development, and is necessary to expand resources around existing projects. The latter is the high-risk activity of looking for new deposits. According to data by Peru’s Ministry of Energy and Mines, annual exploration expenditure dropped from a peak of $993m in 2013 to $746m in 2015. In 2015 some $439m was spent on exploration, a 28.6% decrease compared to 2014. While the total meters of diamond drilling undertaken in 2015 has not fallen significantly, most of this drilling has taken place at already existing mines by firms looking to increase their resource base.
For most junior mining firms, the goal is not to bring their project to production, but to advance it to a stage in which it becomes an attractive take-over target for a major mining firm. In April 2015 Rio Alto Mining, which had successfully developed the La Arena and Shahuindo gold projects in Peru, was subject to a friendly take-over by Tahoe Resources in a deal that valued the former at $1.3bn.
The deal was a bright spot in a bleak two years for mining mergers and acquisitions (M&A). “M&A activity is very important, because it shows that investors are betting on the industry,” Ricardo Carrión, managing director of Kallpa Securities, a local brokerage firm, told OBG. “What we are seeing at the moment is opportunistic approaches from private equity groups, particularly focused on gold, who are looking to pick up distressed assets at knock-down prices.”
If embattled explorers are to stave off the low private equity offers, they will need to be increasingly creative in their financing measures. In June 2015 it seemed that help might come from an unexpected source. The state development bank, Corporación Financiera de Desarrollo, agreed to provide a $70m credit line to Minera IRL for development of its Ollachea gold project. However, a subsequent dispute between management and local communities has jeopardised the project, and this may be the last time that public debt enters mining activities.
Another option open to companies with relatively advanced projects is streaming finance. Under these deals, the streaming firms provide finance in return for a proportion of future production at a set price. In October 2015 streaming firm Franco Nevada injected $610m into Teck Resources in return for annual contributions for 2.8m-3.2m oz of silver from the firm’s Antamina mine, located in the Anchash department.
A third path is for juniors to seek out partners that can provide debt and equity for the development of a project. In Brazil, Luna Gold, owners of the Aurizona gold mine, signed a deal with Australian fund Pacific Road Resources that included $10m in equity to the latter as well as $20m in debt financing. In Colombia, Peruvian firm Graña y Montero, through their subsidy Stracom GyM, won a contract to build and operate Red Eagle Mining’s San Ramon mine near Medellín. The $155m contract was also tied to a private placement that allowed the Peruvian firm to increase its stake in Red Eagle to nearly 20%. “That is an interesting development. Five years ago you would not see a construction firm taking an equity stake in a project,” says Carrión. “With share prices so low at the moment, debt providers and construction groups want equity to increase their upside exposure.”
A Toll Order
The most radical strategy adopted by some Peruvian junior firms is to adapt their very business model. With government efforts to formalise the country’s artisanal miners ongoing, there is increased demand for milling services. A number of foreign firms have built toll mills that can process ore extracted by artisanal miners for a fee. Inca One Gold and Standard Tolling both have plants with a capacity of around 100 tonnes per day (tpd). In October 2015 Anthem United announced first production from its $10m Koricancha Mill, which can process 350 tpd. For many companies the milling process is a means to an end. By turning the firms cashflow positive, they can afford to pay expenses and fund exploration. However, toll mill projects usually require excellent community management programmes if the foreign firms are to negotiate with ore providers.
For years many junior mining analysts have been forecasting an increase in the gold price and a change in explorers’ fortunes for the better. Neither has happened. Nevertheless there is a feeling among many that in 2016 something will have to give. Private equity players and major miners with cash in the bank look well poised to pick up the most attractive assets.