Tuesday, May 8, 2012

Economic Geology

In order for the following chapters to be more understandable, I need to first explain a bit about Economic Geology, and then in a subsequent chapter explain a bit more about Deposit Models.

Economic Geology is the study of ore deposits and mines: 
  • why are they where they are, 
  • how did they form, and 
  • how can I find more?

There are "no-see-um" gold mines along the so-called "Carlin Trend", in north-central Nevada, where gold and mercury are produced. However, the gold is incredibly fine - in the angstrom range - and very low-grade. I talked once with a mine-manager there who told me that he had never once seen a single flake of gold in any rocks from in "his" mine! Yet each of the mines along The Trend were worth literally billions of dollars. There was not much of a grade there - maybe an ounce or two of gold per ton of rock - but there were a LOT of tons of rock. If the average gold grade fell below a certain value - or the claimed deposit proved to be below a certain volume of that low-grade ore-rock, then the mineral concentration there would no longer be an "ore deposit." It would literally, then, not be economic to mine it. If it cost more to get the gold out than you could get ever paid for it, then the whole effort of exploration, development, and production was a bust. 

That's called a losing bet. And you no longer wonder why the fluctuating price of gold matters... 

Therefore the term Economic Geology.

As a graduate student and new father, I helped my family make ends meet by "claim-staking" on weekends for Bear Creek Mining Company. At the time I was working 100-hour weeks supporting a wife and two small children, including working on my PhD thesis in my spare time. Bear Creek was looking for people to go out onto Federal lands in Arizona and New Mexico - lands that their geologists thought might have the possibility of hosting an ore deposit - and stake their claim on the land for them. 

They were following the rules of the US Mining Law of 1872: stake a claim to a piece of federal land up to 600 feet by 1,500 feet in size, and pay $100 to the federal government... and as long as you kept working on it, you could keep it. 

The company geologists sure weren't interested in doing this - staking claims is very arduous physical work, and they figured their college degrees told them they didn't need to do this anymore. That's where slave labor came in: hungry graduate students! We would typically be dropped off by the Bear Creek land manager in remote, always-rugged country somewhere, and hike and survey our way along straight lines all day. Every 1,500 feet (about 500 meters) we would pound a 2-meter (6-foot) stake into the ground. We would then put a piece of paper, describing that sequentially-numbered claim, into a plastic bottle nailed to the top. Then we would pick up our canteens and sledge hammers and the other 19 or so remaining stakes and march another 500 meters over steep hills and evil cholla cactus infested ground to the next pound-it-in exercise.We would do this for an average 12-hour day for two to five days at a time. It was usually so hot that we couldn't eat more than an orange or two during the day. 

Mining companies had to first stake claims to the territory they were interested in, sometimes even before they dared pour any money into geochemical or geophysical surveys (see subsequent chapters) or exploratory drilling. It was such a competitive business that we would quietly drive in and start in the pre-dawn darkness... and still before the first day was over we would see people walking in from seemingly nowhere to try to figure out where the boundaries of this new Bear Creek claim were. 

Bear Creek was a subsidiary of Newmont Mining Corporation, and they were funded for 10 years to do only one thing: find just one more bonanza gold or copper mine. All the salaries, all the equipment, all the chemical analyses, all the geophysical surveys for 10 years were just a huge corporate bet. That bet was that if they put smart people on this task, they could reasonably hope there was a better than 50-50 chance that they WOULD find a new, undiscovered ore deposit. I think they found several during this 10-year period. However, mining companies are notoriously secretive, so that the competition can't "jump" their claims before they can lock up a property and start their drilling program. The drilling program would become far more expensive than the geophysical surveys or the claim-staking exercise, and might itself prove to be a bust. Perhaps there was a "sniff" of gold or copper there, but just not enough to be economic. The company would then just walk away from a property that they had already sunk millions of dollars into.

The claims would then be abandoned, and after a certain amount of time with no work done to "prove" the deposit, another company might come check it out, and stake that land again. They might even then claim the same precise area themselves. This claim-then-drill-then-abandon process would sometimes repeat several times. If the price of copper or gold jumped up and stayed up, then the 3rd time might be the charm.

However, if the drilling program was positive, then the company would start investing in the mining infrastructure. This consisted of, at a minimum: new roads, a mill, a processing plant, perhaps a smelter, distribution and transport infrastructure including huge Euclid ore trucks, etc. It might require five years just to build the durable facilities on the land where they felt there was an ore deposit. That exercise would be predicated on an expected mining-life of 20 years. During that 5-year start-up period nothing - absolutely nothing - would be produced. It was all just investment, a huge bet. The company could easily lose a billion dollars before the first d'ore (mostly gold) or copper brick was even poured in the smelter. If the price of gold or copper took a nose-dive on the international market during that time, they could blow away that much investment money and see nothing for it.

That's actually not a bad business model - because a single producing mine can be worth multiple billions of dollars. 

How important is the price of a commodity? I know that a drop in the value of copper below a benchmark dollar per pound in the 1970's cost some mining companies so many billions of dollars that some went bankrupt. This was caused by a perfect storm: a drop in value brought on by over-production of copper in Chile, and a world-wide recession that slowed down demand. 

I once talked with a little old man missing most of his teeth deep in the Amazonas Territory of southern Venezuela. He was wearing only nylon shorts and rubber boots, wore a home-made straw hat, and was carrying only a machete and a home-made back-pack made out of palm fronds. This pack was full of food and other supplies. When I asked him, he said he was hiking out to "mina nueva" - the New Mine. When I asked a bit more, I found he could tell me the market close on the price of gold... from the previous evening at the London FTSE on the other side of the planet. He could tell me that price to a cent.

Commodity prices are that important. 

The next chapter will be about deposit models - why companies would even make these sort of billion-dollar bets in the first place. Yes, it's more than faith... but sometimes it seems like just barely.


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