Risk and project financing: Making the successful connection

Mining companies must be the consummate risk-takers.

Mines are often located in the most inhospitable places in the world — both geographically and politically. Development costs are huge. The potential return on investment depends upon strong commodity prices, the skill of mining and process engineers, and a shrewd financing strategy. For the most part, mining companies do a great job of assessing and managing the risks involved in mine development and operation, and manage to attract interested investors, despite the numerous risks involved.

Risk management and insurance professionals are often asked to provide risk solutions for mining development projects based largely upon the requirements of project lenders or financiers. This can trigger a reactive process late in the course of arranging project financing. Risks that cannot be transferred or otherwise mitigated, or haven’t been systematically analyzed, can result in inadequate or overly costly solutions and increase the financing burden on project sponsors.

Although mining companies pay a great deal of attention to risk issues in mine feasibility studies, advances in risk measurement provide an opportunity to enhance the quality of that attention.

The independent application of advanced modelling techniques (such as those developed and applied by our sister institution, Mercer Oliver Wyman) allow sponsors to expand the risk assessment process to the life of the mine, facilitate the discussion of risk mitigation techniques, and use data related to discreet risks to drive a more comprehensive, informed approach to identifying more holistic, cost-effective risk solutions.

Describing a given project’s risks in greater detail through the more sophisticated modelling of the individual risk factors associated with it enables a company to better market the project and to negotiate terms of financing (interest rate, equity stakes, credit enhancement) with investment banks and other lenders or funding providers that better match return to risk.

It’s important to detail the financial impacts of the risks associated with a mining project. One method is to use scenario stress-testing to forecast prospective outcomes. This allows for a better understanding of the severity of anticipated risks. It also provides more complete information about the drivers of volatility and exactly which risks could meaningfully change the risk profile of a project, thereby affecting the positive returns funding providers are expecting.

Starting early is the key.

Allowing sufficient time to carry out this type of enhanced project risk assessment can pay major dividends. Making sure that project engineers, construction managers, company personnel and other stakeholders are engaged in risk discussions encompassing project design, procurement, construction and operational life through to reclamation and closure, will ensure that the most comprehensive inventory of risks has been evaluated.

It will enable mining companies to:

* better understand the risks associated with a particular project;

* improve the financing terms they obtain;

* attract the most appropriate potential investors;

* streamline the procurement of insurance or other risk transfer products; and

* enhance the viability of their projects as a whole.

— Michael Hodge is managing director of the mining practice at Marsh Canada in Toronto. For more information, he can be reached via e-mail at michael.hodge@marsh.com