A tale of two projects - how wrong decisions proved 'right'

THIS week Allan Trench looks at two historical examples of asset-level decision-making in the mineral resources sector - and recounts a tale of two situations where decision-makers failed to “expect the unexpected”.
A tale of two projects - how wrong decisions proved 'right' A tale of two projects - how wrong decisions proved 'right' A tale of two projects - how wrong decisions proved 'right' A tale of two projects - how wrong decisions proved 'right' A tale of two projects - how wrong decisions proved 'right'

 

Staff Reporter

Over several years now, successive MiningNews.net editors have advised your scribe that web-based news stories that report upon the various forms of business failure and corporate distress across the minerals sector are amongst the most popular articles when ranked by number of reader views. Indeed, such is our intrigue with all aspects of the business failure of others that articles relating to company distress (in its various guises) come a close second only to those news stories which report upon executive remuneration and rewards.

A positive take upon this high level of interest would suggest that, as a professional group, we seek to constantly improve our skill-base as we learn from the troubles being experienced elsewhere across the minerals sector. A less positive interpretation would suggest that we seek to derive some form of comfort or even escape in the plight of those in less fortunate situations than ourselves. We would be far from alone in responding in this manner to tales of drama and crisis of course: Indeed, a psychological ‘comfort factor’ in observing the challenges faced by others is considered a key driver in the popularity of TV soap operas for example.

But leaving aside the psychological seeds of the popularity of the likes of Ramsay Street and Summer Bay (or Coronation Street and Albert Square in the ‘old country’), this week’s Strictly Boardroom touches upon two real-life mining soap operas – or at least episodes thereof. In so doing it seeks to scratch the surface of the decision-makers analytical process for mining projects and operations.

This is a story of potential disaster – but in both cases the owners of the projects did quite well out of what might (with hindsight of course) be deemed to have been poor decision-making.

Here is Resources Project Case Study number one.

First the up-front summary:

- A minerals project ran three to four times above its original capital budget – and was delivered approaching 18 months later than anticipated.

- In the process of the project delivery, three project managers were sacked for their failure to deliver to time and budget.

Now the after-the-fact analysis for case study one:

- The project returned a Net Present Value several times that approved at Final Investment Decision (FID) Stage by the Company’s board. Why? The 18-month delay meant that peak production was achieved at commodity prices three to four times those of just one to two years earlier – when if the project had performed to specification, peak production would have been achieved at a period of lower prices.

- Capital cost project benchmarking for the project (completed after-the-fact) revealed that the original budget was poorly constructed (and in essence unachievable). The project budget had sat in the lowest-cost decile for the industry on a capital efficiency basis – whereas the project itself had no natural advantages that would lower the capital required below industry average. So three project managers were successively sacked for the equivalent of failing to deliver a Harley Davidson when faced with a budget that would be lucky to stretch to a Vespa.

Now to resources project case study two: Here are the upfront facts.

- A large diversified mining company pared back upon its capital development at a series of underground operations to try to preserve cash drain in a year of very weak commodity price for the specific operations.

- Adequate capital development was budgeted by the company – but was then curtailed.

Now for the after-the-fact analysis:

- The following year, the commodity price ran very hard – rising three to four-fold over the course of the year.

- The company achieved very strong, indeed record profits, as a result – but metal production volumes were amongst the lowest on record for the long-standing operation due to the under-investment of the previous financial year.

Of course everyone can manage in hindsight – but hindsight is nonetheless very informative in these cases.

In case one, serendipity resulted in a better than expected economic outcome. It appears, however, that three project managers were somewhat harshly fired along the way. Definitive benchmarking work to prove the toughness of the assigned project budget should have been instigated early in the process (by the very project managers themselves on appointment if not before).

In case two, the company’s senior decision-makers looked good (returning record profits) – but the opportunity cost missed was a large one. A sub-optimal commodity-specific decision was made to defer budgeted capital spend (when the company’s balance sheet could easily have sustained the capital plan). In an industry segment where the tough years outnumber the good years (or at least did until China came along), the missed opportunity is all the more salient.

So there you have it. Two successful minerals projects thanks to a major up-tick in commodity prices.

Of course, both projects involved decision-making that was actually flawed too. Both cases illustrate that wrong decisions can later be proved ‘right’ – at least in terms of profitability – if not perhaps in terms of realising full potential.

Good Hunting.

Allan Trench (allan.trench@crugroup.com). is a Professor of Mineral Economics at Curtin Graduate School of Business and Professor (Value & Risk) at the Centre for Exploration Targeting, University of Western Australia, a Non-Executive Director of several resource sector companies and the Perth representative for CRU Strategies, a division of independent metals & mining advisory CRU group

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