Commentary: The Top 5 most common fatal flaws in due diligence

The market is ripe for acquisitions of advanced stage exploration and development projects. Uncertainty in future commodity prices appears to be driving investor interest from speculative greenfields projects to those at the preliminary economic assessment (PEA) study level through to pre-construction.

Despite the advanced nature of these projects, financiers are cautioned to look past the more obvious evaluation criteria (e.g. cash flow), most if not all of which are rooted in the more basic and fundamental building blocks of the project, since it is these components that will determine the success of the project.

Based on our experience at Watts, Grifffis and McOuat Limited, the most common “fatal flaws” encountered during technical due diligence reviews are: Incorrect assumptions regarding geological interpretations and/or continuity; inappropriate selection of cut-off grades and use of grade capping; inappropriate composite size selection; optimistic assumptions regarding equipment & infrastructure; and operation integration.

Geological interpretation/continuity — The interpretation of a deposit’s geometry is often described as evolutionary — changing and morphing with each new drillhole and on-going data evaluation. Care should be given in acknowledging that while deposits may share common attributes, they are unique unto themselves, and are a product of human interpretation, bias, and creative license. While they are necessarily limited to the confines of empirical data (i.e. drillhole intercepts), they should not be subject to the technical limitations of the systems used in their estimation (e.g. software).

Conversely, observational bias that affects our ability to learn leads to a lack of proper geological understanding which can often manifest itself in broad stroke, implicit interpolations of mineralization. While this may be suitable for exploration target identification where hard data are often sparse, this can play havoc on mine planning and grade reconciliation in more developed areas where supposed “reserves” may exist.

Cut-off grades and grade capping — The selection of a cut-off grade can have far reaching implications in the estimation of resources. Even at the earliest stages of geological modeling, the bias that can be introduced from selecting a cut-off grade that is too high, or too low, can impact not only the tonnes and grade, but also the fundamental interpretation of the geology. In the case of grade capping, anomalous high values, especially in nuggety deposits, are often overlooked or unnecessarily capped in the absence of sound geostatistical analysis. This is often done simply to impart an impression of being conservative even in cases where geological interpretations are illusory.

Composite size selection — The selection of an appropriate composite size can have tremendous impact on the overall grade (and thus tonnage) of a resource. Increasing the composite length, for example, for the sake of mimicking bench grades for an open pit scenario, can result in grade smearing and thus grade decreases as much as 20-30%. Grade smearing in itself can produce the impression of continuity where in fact none exists.

Equipment — Poorly maintained and improperly specified equipment can have devastating effects on an operation’s bottom line. Besides the obvious delays that can result from the habitual maintenance of older equipment, the sourcing of parts can be onerous and sometimes impossible. The deployment of equipment ill-suited for the task at hand (e.g. large boom jumbo in narrow vein heading, or, a mill with too coarse-grained a grinding circuit) not only shows a lack of recognition of the limitations of the mineralization, but may also point to deficiencies in management’s operational experience. Mining equipment is designed for specific functions and performance is generally degraded when it is modified to do a task for which it is not designed. Once deployed in the mine, bargain-priced equipment may not be such a bargain.

Operation integration — Operations with multiple deposits or development scenarios are often reviewed independently as production silos, rather than as a single integrated operation. Projects most vulnerable to this oversight are those that depend on future exploration to define additional reserves. In these scenarios, there is a growing risk that the time required for discovery, permitting and mine development can exceed the currently planned life of mine.

All of these considerations are for naught if the technical due diligence process isn’t initiated at the very early stages of project evaluation. Unfortunately, this vital review is often delayed until the latest stages of negotiations, after considerable time and resources have already been expended by all parties.

A preemptive scrutiny of these critical path components of projects will almost always identify potential red flags before they become show stoppers at the eleventh hour.

— Kurt Breede, P.Eng., is vice-president of marketing and senior resource engineer at geological and mining consultants Watts, Griffis and McOuat Limited. Visit www.wgm.ca for more information.