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# Swets & Zeitlinger
Perspective
JEAN-MICHEL RENDU
ABSTRACT
Decision making requires denition of objectives and detailed understanding of the project under study. The
options available to the decision maker must be understood, as well as how the project could be improved by
choosing these options. A method must be dened to measure the `utility' of a project. This utility is a
function of `critical indicators', whose value depends on `controlling parameters'. A variety of simulation
techniques can be used to assess the probability distribution of the project utility, depending on which
options are chosen. Risk can be reduced by acquiring more information, choosing exible engineering
solutions, improving managerial or technical expertise, or sharing risk with others. The best option is that
which results in maximum expected utility. Geostatistical simulation plays a critical role in evaluating
geologic risk, but the limitations of geostatistical simulation must not be forgotten: It only models some of
the risk. To fully assess the expected utility of a project, deposit simulation must be combined with
simulation of all other controlling parameters.
INTRODUCTION
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2.1
A plethora of factors make decision making in the mining industry risky. Unless a
deposit is being mined, its geologic characteristics, including tonnage and grade, do
not change, but our knowledge of these characteristics is limited. This uncertainty can
be reduced by additional sampling. Better deposit modeling methods can also reduce
uncertainty even if no additional data is available. There is uncertainty in the amount
of metal that can be extracted from a deposit if a given metallurgical process is
chosen. This uncertainty comes from the need to infer the future performance of the
metallurgical plant from small scale tests run on selected samples which may not be
representative. There is uncertainty concerning economic parameters, including
capital costs, operating costs, and metal prices. Environmental risk presents special
challenges. Political risk depends on the whims of human beings and their governments. Because of the complexity of factors that can affect the success of a mining
venture, investment decisions are often made without systematic risk analysis. But
applicable decision-making methods are well established and their use can signicantly improve decisions.
2.2
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2.3
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Sensitivity Analysis
A sensitivity analysis usually consists of changing the value of key parameters, within
a specied range from the initially estimated value. The parameters that are
considered are those most likely to signicantly inuence the value of the project, and
may include tonnage, grade, metal price, metal recovery, capital costs and operating
costs. The range of values given to each parameter varies depending on the condence
in the original estimate. No attempt is made to estimate the probability that the
parameters will take the values in the specied range.
Sensitivity analysis can be used to determine which are the `controlling parameters',
those which most signicantly inuence the overall project value. Sensitivity analysis
also helps determine which value these parameters can take before the project economics deteriorate to an unacceptable level. Sensitivities are often analyzed by changing
only one parameter at a time, thus ignoring the complex relationships that are bound to
exist. The probability that the project economics will satisfy specic criteria cannot be
assessed in this fashion.
2.4
Utility Function
Risk Analysis
To analyze the risk associated with a project and to decide between alternatives, a
number of steps are followed, either formally or intuitively:
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A technical and economic model of the project is developed. Initial estimates are
made of input parameters such as tonnage and grade of material to be mined,
mining and processing methods, plant size, capital and operating costs, market
value of product sold. This deterministic model is used to calculate the value of the
project's critical indicators and the corresponding project utility, for a given set of
input parameters.
Using the project model, sensitivity analyses are completed to determine the
project's controlling parameters. Controlling parameters are input parameters,
whose values are as yet poorly known but which are expected to signicantly
inuence the project utility.
The uncertainty with which these controlling parameters are known must be
assessed. A probabilistic model of the values that these parameters are likely to take
during the life of the project must be developed. The complex interrelationship
between parameters, and their likely variability in space and time, must also be
taken into account.
The conditions that may prevail during the life of the project can then be simulated.
Monte Carlo simulation, geostatistical simulation, and other simulation techniques
must be used. Each simulation generates a set of values that the controlling
parameters might take.
For each simulation, the value of the project's critical indicators is calculated,
and the corresponding project utility is estimated. Estimating a project utility
for a given set of input parameters is often a time-consuming process. Geostatistical methods can be used to simulate a large number of possible realizations of the grade distribution within a deposit. The time needed to determine
the project utility corresponding to each geostatistical simulation might, however, be prohibitive. How to accelerate this process remains a signicant challenge.
Simulations must be repeated many times to determine the probability distribution
of the project's critical indicators, and of the corresponding project utility. The
range of utilities that a project might have, depending on conditions that might
prevail, can then be analyzed. The probability that the critical indicators will
take unacceptable values, and the probability of project failure, can then be determined.
If the probability of failure is unacceptable, or the range of possible project utilities
is wider than desirable, methods to reduce risk can be investigated. The cost of risk
reduction must be assessed and compared to the increased utility of the project that
is expected from such risk reduction. The challenge is how to determine what the
project utility will be when the information we are considering acquiring has not
yet been acquired. Simulation can be used to quantify the expected increase in
project utility, as a function of the possible outcome of the risk reduction method
utilized.
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A complete risk analysis such as that described above is rarely completed in practice.
For most projects, this approach is intuitively followed, but not formalized. For major
projects, such as those which can `make or break' the company, such an analysis is
well worthwhile. A discussion of specic controlling parameters, and the risk to the
project resulting from the value of these parameters, follows.
3
3.1
There are many sources of uncertainty and the methods used to assess these
uncertainties, and control the corresponding risk, vary accordingly. Some of the most
signicant risk factors are discussed below. Others, such as weather conditions, are
not specically considered. For each project, signicant risk factors must be
recognized and assessed if the best decision is to be made.
3.2
Management
3.3
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The geologic conditions under which a mine will operate are dened as the `state of
nature'. This state cannot be changed, but is poorly known because of limited
information. Getting more or better information can reduce geologic uncertainty.
Systematic and random errors in sample collection, sample preparation, assaying and
data reporting increase risk. Information is obtained at specic data points and must
be interpreted to develop the three-dimensional geologic model needed for mine
planning, thus adding another level of uncertainty. The quality of the model is no
better than the information used to develop it, the method used to make inferences
from data points, and the expertise of those developing the model.
Model creation requires a high level of geologic, mathematical and statistical
expertise. The process is complicated with the need to estimate how the mining
method will inuence the tonnage and grade of ore sent to the processing plant. The
model should be applicable to the evaluation of selective mining as well as bulk
mining. Underground mining is likely to require a model different from that for open
pits. The geostatistical methods used to model the deposit must accommodate these
differences.
Deposit modeling requires modeling of discrete features such as faults or geologic zones, and continuous variables such as grades or metallurgical properties.
Uncertainty in the location of discrete features can be quantied by analyzing
different possible interpretations of the same data, possibly developed by different
experts. Uncertainty in the grade distribution can be quantied by geostatistical
simulation.
3.4
Engineering Design
Engineering design includes design of mine plans, mining and processing facilities,
and infrastructure. These designs are based on assumptions concerning the state of
nature, and the conditions that will prevail during the life of the project. The design
process adds a new dimension to uncertainty, as also to the control of uncertainty. The
best design is not likely to be that which is optimal for one set of conditions, but rather
one that presents exibility and can be adapted to changing conditions.
Choosing the best mining method, and developing the lowest cost, highest
protability mine plan would require perfect knowledge of the state of nature. But the
state of nature is not known; it can only be inferred. The best mine plan is that which
results in the best expected project utility, when tested against possible realizations of
the state of nature and of the other simulated controlling parameters.
Geotechnical information, and the risk associated with imperfect geotechnical
knowledge also plays a critical role in mine design. How to quantify geotechnical risk
and the probability that rock masses will remain stable under stated conditions, has
been the subject of extensive research. A common practice in geotechnical risk
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Metallurgical samples are taken from the deposit. The samples must be chosen to
represent all known metallurgical zones. There is uncertainty in the denition of
these zones.
Bench-scale metallurgical tests are completed on these samples. These tests can be
run on a large number of samples and be representative of all parts of the deposit.
The results can be used for three-dimensional metallurgical mapping. Bench tests
give specic information concerning the sample amenability to small-scale processes tested in a controlled laboratory environment. Extrapolating these test results, to
infer what will be the properties of a full scale processing plant, introduces a
signicant level of uncertainty.
A pilot plant can be built, and much larger samples can be tested. Extrapolation
from pilot plant to full scale operation is much less risky than from bench scale
tests. But pilot plant tests can only be performed on material originating from easily
accessible parts of the deposit. There is a signicant risk that the results obtained
are only representative of a small portion of the deposit.
The processing plant is designed from the results of the metallurgical tests.
Typically, a deterministic approach is followed. A specic ow sheet is chosen, and
the plant is engineered to minimize discounted processing costs during the life of
the project. This approach to plant design is not likely to result in the highest project
utility. At any given time, the mill feed characteristics will differ from those
expected in the life-of-mine plan, and the performance of the plant will differ
accordingly. Risk analysis will motivate investigating the exibility of the proposed
plant design, and the possibility that the plant could be modied when unexpected
conditions are encountered.
3.5
Cost Estimation
Cost estimates are based on specic assumptions concerning the conditions under
which construction will take place. How closely actual costs match original estimates
will vary with the quality of the assumptions and the expertise of the estimator. To
minimize risk, contingency costs are added. The magnitude of these contingencies
varies with the uncertainty associated with each part of the project. The cumulative
effect of adding contingencies to all estimated parameters may result in poor decision
making. Systematic risk analysis should improve the decision process.
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Administrative controls can be used to reduce the risk associated with capital and
operating costs. These controls include a judicious choice of the engineering and
construction companies, technical and nancial supervision, appropriate project management, and contract structures. It is usually advisable to spend more on detailed
engineering, rather than to bring a project to construction early and incur the high cost
of unexpected scope changes.
There is often an inverse relationship between capital costs and operating costs.
The optimal plant size is chosen by comparing the cash ow generated by the various
options available. However, the risk associated with different options should also be
taken into account. A higher capital cost will result in higher nancial exposure during
the early stages of the project, but the corresponding lower operating costs will reduce
the project exposure to changes in metal prices during the entire life of the project.
3.6
Environmental Impact
Managing the risk attached to the potential environmental impact of a project requires
methods different from those commonly used elsewhere. Optimization of time
discounted nancial indicators cannot be used to analyze the environmental cost of an
investment decision. The cost of mine reclamation, often incurred 10 20 years after
mine startup, rarely has a signicant impact on discounted nancial indicators. The
lack of appropriate environmental controls may create liabilities, such as treatment of
acid mine drainage, which will be felt by the company for decades, even centuries
after mine closure. Environmental catastrophes, such as major dam failure, may result
in permanent mine closure and company bankruptcy. The concept of utility function
discussed earlier must be reintroduced here. Some environmental consequences may
be considered as totally unacceptable, however small the likelihood that such
consequences will occur.
Mining operations have a variety of environmental impacts. Risk management will
differ accordingly. Disposal of potentially acid-generating waste can create long term
risk. This risk is assessed by laboratory or large scale tests aimed at measuring the
acid-generating potential of the waste material that will be mined. These tests are time
dependent but their duration is a fraction of the time during which the rock might be
exposed to oxidation during and after mining. Risk is increased by the need to infer
long term properties from short term tests. Long term risk is controlled by designing
waste dumps, such that potentially acid-generating waste is encapsulated in material
that reduces exposure to oxidation. The risk associated with long term treatment of
efuents after mine closure will vary depending on whether passive biological
methods are used or active water treatment facilities. Administrative controls,
including routine inspections, are an integral part of environmental risk management.
The socioeconomic impact of a project varies during its life, and so does the
corresponding contribution to project risk. Early in the life of the project, even before
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construction is approved, expectations are created. These expectations, and fears, can
be local, regional, national or even international. If they are not properly managed,
and kept realistic, the project may fail before it even starts. During construction, the
socioeconomic impact is accentuated by the introduction of a large number of
temporary workers, which has the potential to create signicant local instabilities both
during ramp-up and demobilization. Once the mine is built and in operation, a
relatively stable environment prevails, but there might be an expectation that this
environment will last forever. How mine closure is managed can easily determine the
ease with which the company will be allowed to start another project anywhere else in
the world. The socioeconomic impact of a project is not well measured by project or
even company economics. Moral and social values that transcend economics must be
taken into account.
3.7
Except for projects with unusually high prot margins, the most signicant risk factor
is likely to be the lack of knowledge of the price at which the product of the mining
operation will be sold. Millions of dollars are spent every year by analysts attempting
to forecast future metal prices, with generally poor success.
Technical or fundamental approaches are used to forecast future metal prices. The
technical approach consists in analyzing historical prices, studying long term trends,
periodicities, and short term variability, and developing statistical models, which are
used to simulate future prices. The fundamental approach to price forecasting is an
indirect one, consisting of forecasting supply and demand as well as deducting how
imbalances in the market will affect future prices. The most accurate forecasts are
arguably those that combine technical and fundamental approaches. The risk to the
project can be quantied by developing various price forecasts, assigning probabilities to each scenario and estimating the corresponding utility of the project.
There are many ways to control the risk associated with commodity prices,
including long term contracts, forward sales, hedging and other revenue management
methods. Applicable methods are not the same, depending as they do on whether the
product is coal, iron ore, gold, or diamonds. Revenue management can reduce risk
related to downward price movements, but might also reduce the rewards resulting
from upward movements. Capital investments that reduce operating costs will also
reduce the risk that the operation will have to be shut down because of falling prices.
3.8
Exploration
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3.9
Political Risk
The following risk factors can be included under the header of political risk:
Currency conversion.
Expropriation or creeping expropriation. Under current worldwide political conditions, creeping expropriation is the higher risk.
Political violence. Violence can originate from national instabilities, or can be the
result of local political activities specically targeted towards the company's assets.
Unilateral change of laws and regulations. Laws may be changed to impose new
taxes, increase the cost of labor, or remove the ability to repatriate income, in a way
that is contrary to original agreements.
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JEAN-MICHEL RENDU
Geostatistical simulation plays a critical role in evaluating geologic risk; however, the
limitations of geostatistical simulation must not be forgotten: It only models
geological risk. The assumptions made, and the quality of the information on which
the simulation is based, must always be challenged. Sample locations and sample
values are subject to both systematic and random errors. Geological zones must
be dened, within which required stationarity conditions are satised: Zone denitions are subject to errors, and stationarity is never truly achieved. Mathematical
modeling of the geostatistical properties of the deposit, including the semi-variogram,
requires interpretation of experimental results. The simulated deposit can be used to
analyze different mine plans, including the exibility that each plan has to adapt to
different geologic environments. To fully assess the expected utility of a project,
deposit simulation must be combined with simulation of all other controlling
parameters.
CONCLUSIONS
Risk management has many facets, and how much risk is acceptable varies with the
company. However, the approach to rational decision making remains fundamentally
the same. Even if it is subjective, the method used to assess the `utility' of a project
must be understood, rst of all by the decision maker. This utility is always a function
of `critical indicators' which must be dened. The value of these indicators depends
on `controlling parameters'. A variety of simulation techniques can be used to assess
the probability that the controlling parameters will have specic values at any time
during the life of the project. The results of these simulations can be combined to
assess the probability distribution of the project utility, depending on which decisions
are made. Depending on circumstances, risk can be reduced by acquiring more
information, choosing exible engineering solutions, improving managerial or
technical expertise, or sharing risk with others. The best option is that which results in
maximum expected utility for the company as a whole.
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ACKNOWLEDGEMENT
This article was presented at the International Symposium on Geostatistical
Simulation in Mining, Perth, 2829 October, 1999(1).
REFERENCES
1. Dimitrakopoulos, R. (ed.): Geostatistical Simulations in Mining: Uncertainty Models, Risk Analysis and
Optimisation of Mining Operations. Proceedings of International Symposium on Geostatistical Simulations in Mining, Perth, 2829 October, 1999, CD-ROM; WH Bryan Mining Geology Research Centre,
Brisbane, 2000.