PUSH BACK THE FRONTIER

These are the findings of a recent study conducted by us at the Centre for Resource Studies at Queen’s University in Kingston, Ont.

The choice between mining in frontier areas and mining in established districts is based on a balancing of incremental costs and benefits. The locational costs of exploration and development in remote areas are obviously higher. On the other hand, a continual depletion of ores is taking place at operating mines in established districts. As the higher-quality deposits in these areas are exhausted, there is increasing benefit to be gained by shifting investment towards the higher- quality deposits still awaiting discovery in less accessible areas.

Work recently completed at the Centre for Resource Studies compares the economic potential of mineral exploration and development in the Yukon and Northwest Territories (the less accessible Canadian north) with the more favorably situated and established provinces. The study examines the widely-held mining premise that “more remote” means “less economic.”

The assessment focuses on “base metal” resources, defined for study purposes to include copper, zinc, lead, and molybdenum deposits (with their associated byproducts, mainly gold and silver). In spite of adverse market conditions during the 1982-86 period, base metal mining remains of central importance to the Canadian mineral economy.

This sector makes an essential contribution to regional and northern development and is sensitive to location and the availability of infrastructure.

The economic potential of base metal mining in the Territories and provinces is compared using before- tax and after-tax criteria. Appraisals of exploration expenditures and the returns from economic discoveries are based on documentation of all significant base metal deposits discovered in Canada during the 32 years between 1946 and 1977. Money values are expressed in constant 1983 Canadian dollars (an index of 1.23 can be used to convert these values to 1989 dollars).

The analysis is based on data relating to the Canadian base metal sector, assembled and updated at the Centre for Resource Studies since 1975. Canada-wide exploration expenditures associated with base metal deposits discovered during the 1946-77 period are estimated to be $3.4 billion. The Yukon and Northwest Territories, constituting 40% of Canada’s landmass, accounted for only 10% of this investment. A total of 291 significant base metal deposits discovered in Canada to 1977 are included in the assessment. About 20% of these possible economic deposits were discovered in the Territories.

For planning purposes, this historical record is evaluated in the context of the current outlook. Thus, a central aspect of the appraisal is to determine which of the discoveries would be economic under today’s conditions. An economic deposit is defined as a discovery realizing a total revenue of at least $20 million and a rate of return of at least 8%.

The procedure used to determine the economic potential of exploration and development is as follows. General market projections of future metal prices and smelter payments are combined with other parameters for each possible economic discovery. The deposit-specific estimates depict how each discovery would look today if it was awaiting development. Exploration phase estimates are integrated with the representative characteristics for the development and production phases to portray the time distribution of average cash flows for an economic deposit from the start of exploration to the end of production. Measures of potential value, including the expected value per economic discovery and the expected rate of return on investment, are derived from this distribution.

The following aspects of infrastructure development are fully costed in the assessment:

mine access roads to connect with regional networks;

housing and single-worker accommodation;

townsite and camp amenities;

facilities for fly-in work programs; and

power-generating and power- transmission facilities.

In addition to these infrastructure costs, capital and operating cost premiums are applied to each deposit as a function of its location.

The only item of infrastructure not included in the appraisal is the capital cost of regional roads required where currently undeveloped deposits are remote from existing all-weather road or rail facilities. The study assumes that government, as in the past, will provide regional roads not just in the north but throughout Canada when they can be justified for economic development.

The main finding of the study is that the economic potential of base metal mining in the Yukon and Northwest Territories is significantly greater than in southern Canada. For the “base case” conditions specified in the assessment, the time distributions of average cash flows for an economic deposit in the Territories and provinces are compared in the illustration on page 38. The following before-tax results are derived from these distributions:

* Expected value per economic discovery of $200 million in the Territories compared to $89 million in the provinces. * Expected rate of return on investment of 32% in the Territories compared to 16% in the provinces.

The general validity of these comparative results has been tested by evaluating the sensitivity of the economic potential of base metal mining in the two study areas to wide ranges of values for key study parameters around the assumed base case conditions. The sensitivity analysis confirms that base metal mining potential in the Territories is significantly greater than in southern Canada.

The combined effect of profit-based taxes — federal corporate income tax, provincial and territorial corporate income tax, and provincial and territorial mining tax — is also examined. The impact of these taxes on investment incentive is found to be more severe in the provinces than in the Territories. For example, for the base case conditions specified in the evaluation, 58% of the value realized from base metal mining in the provinces would be paid to government in profit- based taxes, compared to 47% in the Territories.

The lower incidence of taxation in the north is a consequence of relatively low territorial tax rates. A more fundamental question arises with respect to the before-tax results — why is the economic potential of base metal mining in northern Canada significantly greater than in the provinces?

In endeavouring to explain this finding, the potential value of base metal mining is broken down into its two main components:

* the average exploration expenditure per economic discovery; and

* the average return from development and production for an economic deposit.

Study results show that average discovery costs are much lower in the Territories. Under base case conditions, for example, the average exploration expenditure per economic discovery is found to be $12 million, compared to $43 million in the provinces. This difference is explained by three factors:

deposits are relatively easy to find in the Territories because bedrock exposure is better and the land surface is more readily observable
;

exploration tends to be more efficient in the north due to smaller number of active companies and less duplication of effort; and

depletion is more advanced in the provinces, resulting in a smaller proportion of undiscovered deposits and deeper, more costly exploration programs.

The return potential for economic deposits in the Territories is found to be comparable on average to the returns offered by economic discoveries in southern Canada. For base case conditions, the net present value of an economic discovery at the start of development averages $263 million in the Territories and $268 million in the provinces. The average rates of return on development investment are 39% and 35% respectively.

The high-cost premiums associated with developing and operating mines in the north have been fully accounted for in these return assessments. The economic deposits discovered in the Territories to date are found to be of relatively high quality, particularly in terms of their closeness to the earth’s surface, permitting the application of low-cost open-pit and shallow underground mining methods.

While base metal deposits in the Territories are remote in a 2- dimensional geographical sense, deposits in the provinces are becoming increasingly remote in the third dimension — depth below the surface. Study results indicate that the incremental costs associated with these two types of remoteness cancel each other out. The return characteristics of economic base metal deposits in the Territories and provinces are therefore similar.

The comparative advantage of base metal exploration and development in the Territories is explained by the time trends that underlie the phenomeno n of pushing back the northern mining frontier.

Study results show that base metal mining in the Territories and in the provinces are at quite different stages of maturity.

Base metal exploration and development in the north lags at least 20 years behind southern Canada. Experience in the Territories during the 1946-77 period is found to parallel base metal mining in the provinces prior to the Second World War. For example, prospecting accounts for almost two-thirds of the base metal deposits discovered in the north. Also, the quality of the northern discoveries is shown to be comparable to the quality of deposits discovered prior to 1946 in the provinces. This time lag between base metal mining in the provinces and in the Territories (the main reason for the superior economic potential of northern Canada) can be expected to continue for many years.

Base metal exploration trends in Canada since 1977 are revealing. Exploration expenditures were at a high level until 1981, averaging about $150 million per year. Drastic cuts in base metal budgets then followed in response to the recession in world markets and the rush into gold. By 1986, less than $75 million per year was being expended on exploration for base metal deposits in Canada.

The successive reductions in base metal exploration which occurred followed a systematic pattern:

* more remote programs tended to be sacrificed first;

* an increasing share of the exploration activity was undertaken by the producing companies; and

* exploration programs were concentrated in the vicinity of operating mines.

Consequently, a greater proportion of base metal exploration activity has been taking place within the provinces. The share of Canadian expenditures accounted for by the Yukon and Northwest Territories fell to less than 10% in the mid-1980s from more than 20% in the late-1970s. Even in the north, most activity came to be focused on targets around existing base metal operations.

Several notable base metal deposits have been discovered as the result of exploration carried out since 1978, virtually all of them near former or current mines. This recent experience shows that good discovery possibilities continue to exist in established mining districts with long, intensive exploration histories. While the value of these discoveries to the mining companies and communities concerned cannot be questioned, the number of base metal deposits found during the 1978-86 period is remarkably small when compared to total exploration expenditures, which were in the order of $1 billion. Consequently, the expected value of base metal exploration in Canada during this recent period is decidedly negative, with more money going “into the ground,” in time-adjusted terms, than coming out.

Study results indicate that, on the basis of long-term economic potential, there is a bias to under-invest in base metal exploration and development in the Yukon and Northwest Territories, and to over-invest in the provinces. It would be surprising if this bias did not, to some degree, extend more generally in Canada to:

* other high- and medium-unit- value mineral commodities; and

* less-accessible regions versus established mining districts within the provinces.

Beyond these boundaries, we can only conclude that “more remote” does not necessarily mean “less economic.”

During the 1980s, attention has focused, as never before, on productivity improvement and the competitive position of Canada’s mining industry in international markets. Both the associated investment and the positive results achieved, which in some cases are substantial, have mainly concentrated on existing operations.

Base metal exploration has until very recently been drastically curtailed and increasingly focused on established mining districts in order to protect mining assets, processing plants and related infrastructure. This type of corporate strategy, which is of a defensive and short-term nature, has been remarkably successful in enabling the Canadian mining industry to survive a prolonged world-wide market recession.

Looking ahead through the 1990s, to the turn of the century and beyond, there will, however, be a different set of requirements for survival and prosperity. Higher-quality mineral deposits are the key ingredient for enhancing mining productivity and strengthening competitive standing in the long term. Study results show that there are economic advantages to finding and developing mineral deposits in frontier regions such as the Yukon and Northwest Territories. To realize this superior economic potential, Canadian mining companies must shift their attention away from shoring up existing assets and sunk costs, towards the wealth-creating opportunities that await successful exploration and development in northern Canada.

Mining companies cannot, however, take this initiative on their own. Government has an essential up-front role to play in providing the necessary network of regional infrastructure. A broad program of public sector investment appears to be justifiable, based on the economic potential assessed in this study.

The federal government’s Northern Mineral Policy provides a coherent and logical framework to promote realization of the mineral potential of the Yukon and Northwest Territories. Government funding and programs are now required to give meaning to the policy.

An improved transportation system is the key to stimulating major advances in base metal mining in the Territories. The most critical requirement is the construction of all-weather roads from the southern and western fringes of the region into the interior. Another economic priority for large- scale base metal development is the provision of regional power-generating facilities. These are the two areas where government investment would have the greatest impact on realizing the economic potential of base metal mining in the north.

The attractiveness of base metal mining potential in the Yukon and Northwest Territories presents Canada with a great, long-term challenge. This is an issue on which there is much common ground between industry and government. An unrivaled opportunity exists for:

productivity improvement and profitable mining company investment in exploration and mine development;

supporting economic development of the Territories and improvements in the well-being of northern residents;

streng
thening Canada’s competitive position in world mineral markets; and

wealth creation for Canadian society.

However, realizing this opportunity will not be easy. It requires a basic shift in corporate strategy and the implementation of a major government investment program. In no small measure will the vitality of the Canadian mineral economy in the year 2000 depend on the extent to which these changes enable us to push back our northern mining frontier. Leo Verleun is an independent mineral economics consultant based in Merrndijk, the Netherlands. Brian Mackenzie is a senior research associate of the Centre for Resource Studies and a professor in the Dept. of Geological Sciences at Queen’s University in Kingston, Ont. Their study, “Mining Potential in Northern and Southern Canada: Guidelines for Regional Development Policy,” is available from the Centre for Resource Studies, Queen’s University, Kingston, Ont. K7L 3N6.

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