Stage Derisking

Derisking a project in 10 stages

The derisk ratio is an estimation of the chance of a project to reach commercial production, being fully derisked hypothetically, this concept is derived from the 9 stage model of John Kaiser:

As a very global indication of value, a project NPV can be multiplied in the latter stages (PEA and further) with the derisk ratio to determine the NAV at that stage, which Kaiser applies in the following way:

To find out what Kaiser exactly means by Dream target fair value channels just read one of his presentations.

He also presents some useful concept strategies to look for interesting juniors, one better applicable then the other or might deliver different stockpicks when doing your own due diligence, but nevertheless interesting.

This concept is used in addition to the life cycle graph of Brent Cook, which shows the considerable amount of speculation in the earlier stages:

As this price action development not always or that strongly occurs (not much coverage, not very good results, metal prices down, etc.), it is recommended not to follow this approach too literally when doing due diligence on a mining stock, especially not in a bear market like we are encountering at the moment (2015), where often nothing seems to be able to meaningfully move a mining stock.

Nevertheless it is a good indicator what sentiment to expect at certain stages. Of course every mining project is different, and specific/extreme issues can alter derisk ratios. For example, when a project encounters delays, or problems (or even fails) to get permits or financing, the NPV value can drop to early stage levels after expected timelines are grossly violated. This doesn't always have to do with management, when metal prices are low like now (end of 2015), a lot of projects aren't economically viable and will probably not get capex funding.

John Kaiser always uses more or less linear "channels" going up for companies advancing through his 9 stages of development.  Much of this depends on market/commodity sentiment, as those forces can completely distort the models of Brent Cook, John Kaiser or my derisking tables. For example back in 2010 or 2011 when the commodity market was red hot, almost every news release created an uptick, and just one good drill result could mean 50% for an explorer or more over the course of a few days. Today, such announcements don't cause any price action except very surprising news.

Just keep in mind that all 3 models are very global indicators, based on extensive experience in standard situations, and I use Brent's model (and my own experience in price actions on catalysts) to estimate added upside/downside or project derisking on top of my own project derisking tables, derived from Kaiser's model.

Here are 4 examples of my project derisking tables:



Iron ore:

Rare earths:

Price action that is often witnessed is a spike after a good resource estimate (less frequent as markets/investors usually have pretty solid estimates for it), PEA or PFS, and seeing the share price coming down soon afterwards, often normalizing at a slightly higher level within a few weeks. When such news is a complete gamechanger, the uptick could stick as interest of large funds, investment banks etc could be triggered. The PEA and PFS stages are often strong catalysts when results are good, as markets have a bit more trouble anticipating project metrics which can be very specific. The PEA, when good, is often generating a surprise effect, and the PFS is the strong catalyst of proving the PEA surprise. Although gold is a very speculative commodity with big moves up and down, a project already can be viable at a very small scale at current low gold prices, so the capex for most gold projects is generally within certain bounderies (generally below financier thresholds of $200-300M), meaning that when a project is close to these thresholds, it has a significant chance of being financed and constructed.

Therefore a relatively large part of development risks is already taken away after the FS and permitting if the project isn't too large. This is different for copper and especially iron ore, which need economies of scale most of the time as the value per tonne of mineralized rock is lower. Especially iron ore projects are almost always huge and need a very large capex (at least over $1B), and an average copper project capex generally superseeds the $500M threshold fairly easy most of the time. As copper has a better long term outlook compared to iron ore at the moment, chances are that iron ore prices stay low for a long time, whereas copper prices are forecasted to go up in a few years time, when the consumer economy in China takes over the current investment/construction driven model. Therefore, in my view at least, a fully permitted iron ore project in FS phase is almost impossible to finance nowadays (end of 2015), hence the large risk/NAV discount.

Rare earths are a league of its own regarding risk management. As China is almost completely controlling rare earth pricing as part of some kind of geopolitical strategy, it could be the most risky and speculative commodity to build a project on. Even after an uptick in pricedecks, when a project could be very lucky to get financing, it still isn't sure if or when China could let rare earth prices crash again, rendering the financed project completely unprofitable when it is about to go into commercial production, or even after that when the company still has large interest/debt obligations. Look what happened to Molycorp. Therefore to me a rare earth project will always carry a substantial amount of added risks, until a genuine free market for rare earths has developed.

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