Exploration Making a Comeback

But Companies Urged to Embrace Digital Age

One of the dominant themes emerging from this year’s PDAC convention is that exploration is making a comeback but requires a different approach in the digital age.

More than 24,000 people from around the world poured into the Metro Toronto Convention Centre – up from 22,000 last year – to visit company booths and hear representatives from finance, consulting and gold mining speak about the importance of greenfield exploration and how to do it better.

“True value is found at the end of a drill bit,” concluded Mark Bristow, CEO of Randgold Resources, at the keynote session on what makes a successful mining company. Bristow attributes Randgold’s success – its share price is one of the few in the gold sector to appreciate over the past decade - to a dedication to exploration and geologists, even during downturns.

The good news is that exploration spending appears to be on the cusp of a turnaround after years of decline in which non-ferrous exploration budgets dropped, according to S&P Global Market Intelligence, from an all-time high of US$20.5 bn in 2012 to US$6.9 bn in 2016. 

“I believe the industry bottomed out in 2016 and is on its way up, and by 2020 exploration spending will have increased by 40%,” said Richard Schodde of Australia’s MinEx Consulting, who has become one of the world’s leading experts on exploration trends.

But if there isn’t a revolution in exploration strategy to accompany the spending, the industry risks continuing on the path of wealth destruction set in the past decade. The average return on a dollar invested in mineral exploration was 47 cents from 2017-2016, according to Schodde.

That’s where technology comes in. There is a massive opportunity to pull exploration into the digital age by using “exponential technology” (such as AI) to generate wealth, said George Salamis, executive chairman of Integra Gold. Mining lags just about every other industry in this respect.

Integra and Goldcorp co-hosted a “Disrupt Mining” event at the convention, a “shark tank” style competition where each of five finalists pitched their innovations to a panel of judges for a $1 mn prize. One of the co-winners was Kore Geosystems, which offers real-time data on drill rigs, allowing geologists to make on-the-spot decisions about whether to continue drilling, or where to target next. Another finalist had developed a machine-learning algorithm to improve mineral exploration targeting.

“Mineral exploration has not had its ‘Uber’ moment yet, but it is coming,” said Salamis. “Oil and gas had this moment in the 1990s with the advent of 3D seismics. That led to a tripling of discovery rates.”

One of the biggest impediments to reaching this goal is the reluctance of companies to share data said Salamis, who launched the crowdsourcing “Gold Rush” challenge to find new targets at the Lamaque gold project in Quebec last year. IBM was a Gold Rush sponsor.

“Cast open your data to the masses, to as wide an audience as possible, not just the geoscience community,” he said. “There are technology giants that are just begging for an entry point into what we do. They will sponsor you.”

Exploration in 2026

What will be the best exploration strategies in 2026? That difficult question was put to consultant Jon Hronsky of Western Mining Services in Australia during the keynote session at the PDAC’s annual conference in Toronto.

Hronsky says the industry’s “unequivocal failure” to grow by mergers and acquisitions (M&A) - more than 90% of the value of assets purchased over the past decade have been written off - will force companies to reconsider greenfields exploration as a fundamental means of wealth creation.

Not that exploration has fared much better in recent years. Despite a 10-fold increase in spending globally since the beginning of the century to a peak of $30 billion in 2012, the discovery rate has dropped.

“Exploration will have to have a much sharper strategic focus than it has had in the past few decades,” says Hronsky. “In my opinion, there are massive opportunities for improvement.”

For example, explorers must focus on high value, tier one ore deposits that provide a return even during commodity downcycles. Not only are these deposits more attractive from an economic standpoint, they are more likely to gain a social licence to operate because they have footprints smaller than the large, low grade deposits than came into vogue in the late 20th century.

Second, companies must be more predictive in their exploration strategy because deposits are more likely to be concealed by cover than they once were. Consequently, access to geoscience data will become a significant competitive advantage and investment will migrate to those countries that provide it.

“It doesn’t matter how good your predictive models are if you have no data to apply them to,” said Hronsky, whose own targeting work led to the discovery of the West Musgrave nickel sulphide province in Western Australia. “The availability of geoscience data, which varies dramatically for jurisdictions around the world, starts to become a important strategic consideration.”

Yet another factor is the type of cover overlying mineralized systems. The ideal cover for exploration is a few metres of sand over weathered basement, whereas thick cover in areas where topography varies presents much more of a challenge.

Just as the petroleum industry moved gradually from shallow land based operations a century ago, to shore-based drilling, to deep sea exploration, so must the mining industry start looking under manageable cover and proceed from there.

Innovation, for example advances in drilling technology (i.e. coiled tubing) that allow explorers to drill deeper for a fraction of the price of conventional diamond drilling, is changing the definition of which regions are prospective. Even automation at the production end of the spectrum will determine the kinds of deposits that will best reward exploration investment.

But who will pay for all of this activity? Hronsky argues that the failure of recent exploration carried out mainly by juniors with access to risk capital has eroded trust in the sector. In order to restore that trust and regain access to sophisticated risk capital, he says the industry must move towards an exploration aggregator model that links capital to promising portfolios of projects and technical expertise.

The aggregator could take the form of a direct agent, a specialized third party or a senior mining company that lends it credibility to the projects.

Regardless of where the financing comes from, exploration groups must ensure their technical capability matches the requirements of “the next generation of discoveries, not the last generation that has already been made” and their project portfolio is assembled in a strategic way that allows individual projects to relate to, and learn from, one another.

Focus on the high grade, get better at predicting targets, be open to disruptive technologies, create a synergistic project portfolio and adopt the aggregator model of financing: Hronsky’s key takeaways may provide a way for the industry to improve the abysmal discovery rates of the recent past.

Tax incentives for Exploration

The Canadian government has extended the tax credit for mineral exploration conducted within the country by one more year.

As junior mining companies struggle to secure capital during challenging conditions for the sector, the 15% Mineral Exploration Tax Credit (METC) helps to keep investment flowing, Canadian Finance Minister Joe Oliver told delegates of the PDAC conference in Toronto. The PDAC had been lobbying the federal government to increase the METC to 30% in the months leading up to the conference. 

The credit complements Canada’s “Super Flow-Through” system, which allows companies to deduct 100% of their exploration expenses, then pass those expenses on to shareholders who, in turn, can claim them against personal income. With the recent announcement, the definition of “eligible” expenses has expanded to include expenses related to environmental permitting and community consultation

Since 2006, when the METC was introduced, Canadian junior mining companies have raised about $5.5 billion for exploration using the flow through system. In 2013, more than 250 companies issued flow-through shares eligible for the tax credit to at least 19,000 investors.

Above and beyond the enticements offered by the federal government, most of Canada’s provinces and territories offer their own incentives to explore locally. The province of Quebec, for instance, has a basket of incentives for both companies and their investors including:

• 125% deduction of exploration expenses for producers in the north

• Venture capital for exploration through organizations such as the Caisse de dépôt et placement du Québec and SIDEX

• C$250-million fund that makes investments of C$5-20 million in Quebec companies that have reached the development stage (announced in 2013)

• Funding for aboriginal exploration groups such as the Cree Mineral Exploration Board

• Tax deductions up to 150% of the cost of flow through shares for investors

So, if you live in Quebec, earn more than $135,000 and invest C$1,000 in the flow-through shares of a junior company, the after-tax cost of your purchase would be $334. That’s not a bad deal for an investment that has the potential for significant capital gains if the junior makes a discovery.

Ring of Fire Deadlock Exposes Global Reality for Mine Projects

Strong opinions about the proposed “Ring of Fire” development in the James Bay lowlands of northern Ontario dominated the keynote session at the PDAC conference in Toronto in early March, but there was hardly an audience to hear them.

Although the conference drew more than 25,000 attendees, most of the seats in the giant theatre were empty during the keynote, suggesting investors have tired of hearing about the $60 billion worth of minerals that seem destined to remain in the ground indefinitely, or at least until government, industry and First Nations groups agree on a way to mine them.

The deadlock was perhaps best illustrated by Natural Resources Canada Minister Joe Oliver’s reluctance to actively participate in the “smudge” ceremony at the opening of the conference, a cleansing ritual practised by most First Nations that is meant to sweep away negative energy and emotions. 

Still, the complex issues affecting the Ring of Fire are becoming more relevant to resource developments across Canada and throughout the world. Aboriginal and community groups are more powerful then ever before and mining projects will simply not proceed without their blessing.

“This is a systemic problem which the world is addressing in a variety of ways,” said Bob Rae, former Ontario premier and lead negotiator for the Matawa Tribal Council that represents aboriginals in the Ring of Fire. “The challenge of social responsibility, transparency, accountability and inclusion is not simply an Ontario challenge or a Canadian challenge, it’s a challenge worldwide.”

In Canada, the Supreme Court has determined that there is a duty to consult First Nations about resource projects, but has left it up to governments and First Nations to negotiate what that duty means. This has led to a string of legal battles nationwide, with First Nations groups emerging mostly victorious.

The Ring of Fire is complicated by its location within the province of Ontario, where treaties with First Nations were signed more than a century ago. Provinces that did not have treaties, such as Quebec and British Columbia, are much further ahead in their resource partnerships because they started negotiations with a clean slate, said Rae.

The poverty, health problems and social dysfunction endemic in First Nations communities are added challenges because it’s difficult for leaders to focus on resource negotiations when their communities have no running water, or their youth are committing suicide.

But the image of the disenfranchised aboriginal is no longer relevant, argued Bill Gallagher, who served as a strategist to the Voisey’s Bay Nickel Company when the nickel miner was forging native impact and benefits agreements in Newfoundland & Labrador.  On the contrary, he told the audience that First Nations groups are “riding a winning streak” with a power over resource development that industry underestimates at its peril.

“Whoever aligns with the aboriginals will have the most control in determining development of a project,” Gallagher said. “They have fundamentally reordered the legal underpinnings of the review process for resource projects.”

Global Mining Finance 2014

Several factors conspired to make 2013 one of the worst years in recent memory for North American mining companies. Metal prices fell, led by gold with a 28% decline, while costs for labour, energy and steel continued to rise. Geopolitical risks escalated as jurisdictions erected legal and regulatory roadblocks to development or imposed higher taxes and royalties on production. Investors fled the sector, spooked by massive project writedowns and suspensions, while remaining shareholders rebelled by ousting senior management, especially in the gold space.

The resulting disruption of the flow of projects from junior explorers to mid-tier and senior producers quelled merger and acquisition activity. Seniors attempted to sell off non-core assets but, without a market among their peers, were forced to take some projects off the block. Juniors companies found it next to impossible to raise money on the equity markets as investors clung to projects with imminent cash flow or abandoned the sector altogether.

Signs of life for M&A

Global merger and acquisition activity in the mining sector fell 31% in the first half of 2013, according to PwC, and the third quarter looked equally sluggish. But towards the end of the year there were signs that the beleaguered junior sector was beginning to consolidate in the interests of survival.

Among other smaller deals, Primero Mining agreed to buy Brigus Gold to create a mid-tier gold producer based in the Americas. The all stock transaction, valued at about $200 mn, combines Brigus’s Black Fox gold mine in Ontario and Goldfields project in Saskatchewan with Primero’s operations in Mexico to produce about 250,000 oz. gold per year.

Likewise, Mercator Minerals agreed to be swallowed by Russia’s Intergeo MMC to create a growing copper miner that will combine the Mineral Park mine in Arizona and the El Pilar project in Mexico with Intergeo’s Ak-Sug copper project in Siberia. The deal signals an end to Intergeo’s attempts to launch an IPO on the TSX in an unreceptive market.

And long-time neighbours Asanko Gold and PMI Gold plan to merge in an all-share deal valued at $183 mn to create a mid-tier gold company operating in Ghana with the potential to produce 400,000 oz. annually.

 “There is more activity on the smaller scale, but it will take a little longer for the monster assets to get digested by the market,” says Allan Fordyce, managing director of investment banking for BNP Paribas.

Small companies acquire major assets

Most of the senior producers have lost interest in acquiring assets because they are under pressure from shareholders to clean up balance sheets and boost profitability. Gold producers in particular are looking inward after an annual decline in the S&P/TSX global gold index of 48% that far exceeded the 28% drop in gold prices.

“The only company in a really good position to buy is Teck, because it has a solid balance sheet and cash flow,” says Fordyce. On the contrary, many of Teck’s peers are selling non-core assets to smaller companies with access to capital and lower overheads.

In April, for instance, BHP Copper Inc., a subsidiary of BHP Billiton, sold the Pinto Valley copper mine in Arizona to Capstone Mining for US$650 mn. The transaction, financed by two $200 mn loans from Scotiabank, gives Capstone its third mine as it strives to become an intermediate copper producer.

Similarly, Rio Tinto Nickel, a subsidiary of Rio Tinto plc, sold the high grade Eagle mine in northern Michigan to Lundin Mining for US$325 mn. The deal, also financed by bank loans, gives Lundin an underground nickel-copper mine in a low risk jurisdiction to add to its base metal operations in Portugal, Sweden and Spain.

Sherritt International, meanwhile, sold its portfolio of coal and potash royalties to Newfoundland-based Altius Minerals Corp. for $481 mn and a suite of coal mines in Alberta and Saskatchewan to Colorado-based Westmoreland Coal for $465 mn.

And Newmont Mining is selling the Midas gold mine and mill in Nevada to Klondex Mines for US$83 mn. The acquisition, financed by a combination a $35 mn package from royalty company Franco-Nevada, a $35 mn private placement of subscription receipts and a $25 mn private placement of secured notes, will complement Klondex’s nearby Fire Creek project.

“These deals are indicative of just how much pressure the large majors are under to improve their balance sheets and profitability by walking away from or monetizing non-core assets,” says Mark Zastre national leader of Grant Thorton’s mining sector. “We’ll see more of these acquisitions by smaller companies, possibly financed in non-traditional ways.”

Junior financings plummet, TSX salvaged by Barrick

Financings for juniors on the Toronto Venture Exchange (TSX-V) fell to just over one billion dollars for the year to November 30, an 80% decline from the same period in 2011, when financings reached $5.5 bn, and less than half of what was raised for the first 11 months of 2012.

“Over the past year or two, investors have become more risk averse and as a result they have moved into other sectors,” says Orlee Wertheim, head of mining business development for the TMX Group. “Fewer financings are being done by early stage exploration companies, which make up a large part of the mining companies on the TSX-V, and the financings that do happen are smaller in terms of dollar amount. Companies don’t want to dilute their shareholders any more than they have to.”

One prerequisite for substantial financing on the TSX-V this year was access to a project that generates, or is about to generate, cash flow. The largest financings were completed by SantaCruz Silver Mining ($40.4 mn), owner of one producing mine (Rosario) and two advanced-stage projects in Mexico; Corsa Coal ($31 mn), a Toronto-based company with operations in the U.S. Appalachian coal belt; and Atico Mining ($19.4 mn), which recently purchased the El Roble copper-gold mine in Colombia.

There were only six mining IPOs on the TSX-V in the first 11 months of 2013, compared with 38 at the same time in 2012. Of those new listings, five were companies with projects in Canada while one (Aurania Resources) had a gold project in Switzerland.

“The companies that are getting financed typically have projects in more stable jurisdictions,” says Wertheim. “We’re seeing a trend towards financings for projects in Canada, the United States and other jurisdictions where there is a good rule of law and companies have some certainty of title, taxes and royalties.”

Financings on the senior exchange, the TSX, were more stable, falling 23% from the $6.9 bn raised during the same period last year. However, a single US$3 bn bought deal financing completed by Barrick Gold late in the year skewed the numbers.

Barrick’s massive financing, though scorned by shareholders, was enough to vault mining back into first place for equity capital raised by sectors within the TMX Group, ahead of real estate ($5.2 bn), oil and gas ($4.6 bn) and financial services ($4.4 bn). Other major raises included secondary offerings by Platinum Group Metals ($180 mn), Detour Gold ($176 mn), Allied Nevada Gold ($154 mn), and Guyana Goldfields ($100 mn).

Predictions that hundreds of companies would lose their listings this year as they ran out of cash did not come true. There were 67 delistings of mining companies on the TSX and TSX-V in first 11 months of the year. Of those, 35 were the result of M&A, 20 were at the request of the companies themselves and only 12 were removed because they did not meet listing requirements, according to Wertheim.

But the overall market capitalization of the sector has fallen dramatically, from $481 bn in late 2011 to $225 bn, as investors sold off mining equities in the wake of falling commodity prices, underperforming projects, missed deadlines and moves towards resource nationalization in several jurisdictions where North American companies operate.

The S&P/TSX Venture composite index, the bellwether of the junior sector, hovered just above 900 towards year end, off 24% over 12 months. The index reached a peak of 2440 in March 2011 and has been in steady decline ever since.

CNSX aims to take advantage of carnage

A smaller but less expensive exchange may attract some of the juniors. The Toronto-based CNSX has only a tenth of the listings of the TSX-V, but recent injections of capital may give the tiny bourse the traction it needs to compete seriously for mining listings.

Over the past year, both Dundee Corp.’s Ned Goodman and Caldwell Financial founder Thomas Caldwell have purchased significant stakes in the CNSX and are actively promoting the exchange as home for mining companies who want cheaper listing and filing fees and less red tape.

“I have been impressed for some time with CNSX’s approach to helping entrepreneurs access the public capital markets in Canada,” said Goodman at the time of the investment. “The CNSX model reduces the time and expense companies face in going public, and in maintaining a listing, along with a high level of continuous disclosure.”

Private equity: will it fill some of the void?

Meanwhile, mining bargains are proving too attractive to resist for the traditionally conservative private equity sector. At mid-year, Toronto-based Brookfield Capital Partners provided a $130 mn loan to North American Palladium (NAP) for the expansion of NAP’s Lac des Iles mine in Ontario, while Calgary-based Matco gave Yellowhead Mining an $8 mn convertible loan to continue work on the Harper Creek copper-gold-silver project in south-central British Columbia.

Larger U.S. equity firms, including Apollo Global Management, Blackstone Group and Caralyle Group continue to circle the sector, though none have announced a deal on the scale of TPG Capital’s $500 mn investment in X2 Resources, a new company run by former Xstrata CEO that is planning to build itself into a mid-tier diversified producer.

Closer to the riskier end of the spectrum, Toronto-based Minvest Partners is considering advanced exploration projects that can purchased cheaply, upgraded over a few years, then sold to producers.

Companies such as metals trader RK mine finance, part of the Red Kite Group, are also offering a range of financing to junior and mid-cap mining companies. For example, Asanko Gold secured $150 mn from RK for its Esaase gold project through a combination of debt and off-take financing.

But there has been more talk than action with respect to private equity investments in the mining sector. Although some firms have recruited ex-CEOs for their expertise, their overall ability to professionally vet projects remains limited.

“I’m still sceptical,” says Zastre. “Private equity has traditionally been more involved in oil and gas than mining because mining is so cyclical and it’s much harder to predict when cash flow will be realized.”

Major development projects, major headaches

One of the more disturbing trends to emerge in 2013 was the failure by the industry to deliver new projects. “Several major deposits have come to a halt because of geopolitical risk, cost escalations for labour, steel and energy and the infrastructure requirements for remote projects,” says Miranda Werstiuk, vice president of IBK Capital.

The biggest disappointment was Pascua Lama, the massive gold mine on the border of Chile and Argentina that Barrick Gold has spent US$5.4 bn to develop. Barrick shelved the project indefinitely in October, citing lower gold prices as well as legal and regulatory obstacles imposed by the Chilean government. Other suspensions include:

• Goldcorp’s $3.9 bn El Morro gold-copper mine, now dormant while the Chilean government considers an appeal by indigenous communities that say they were not properly consulted about the project.

• Kinross Gold’s Fruta del Norte gold project, purchased for US$1 bn in 2008 but abandoned this year after Kinross failed to reach an agreement with the Ecuadorean government on the terms of a windfall tax.

• Colossus Minerals’ technically complex Serra Pelada gold project in Brazil, put on care and maintenance after a last ditch financing attempt with Arias Resources Capital Management failed. Colossus, once a junior market darling that soared to $8 per share in 2011, opened 2014 trading at seven cents. 

• Cliffs Natural Resources $3 bn Black Thor chromite project in northern Canada, suspended indefinitely because of uncertain timelines and the risks associated with developing infrastructure.

Outlook

There doesn’t appear to be any relief forthcoming as 2014 unfolds and new supplies of copper, nickel and gold start entering the market.  “I think it’s going to get worse before it gets better. There will be more companies that walk away from projects, delist or get acquired,” says Zastre. “We won’t be through the worst of it until we have a gold price that everyone is comfortable with.”

But the inability of several companies to make money at current precious metal prices suggests a bottom may not be too far off for the gold producers. Fordyce argues that at total sustaining costs of $1000 per oz. or more, gold does not have much room to drop without a major cut in production “We’re probably close to bottom and its not going to get much worse” he says.

For the base metal sector, Fordyce is optimistic in the longer term because the economies of both the United States and parts of Europe are finally beginning to brighten. He says tapering of the bond buying program in the US – a signal that the feds are less worried about economic prospects - could have a positive impact on base metal prices.

As for M&A, he says 2014 is going to be a lot more active than 2013. “I think you are going to see much more consolidation on the junior level,” he says.