The economics of diamond projects in the Canadian Arctic

CIM Bulletin, Vol. 1, No. 8, 2006

W. Bullen and J. Zhang

Since the discovery of diamonds in the Lac de Gras area of northern Canada in 1991, the Canadian Arctic, incorporating the Northwest Territories and Nunavut, has become a prime locality for diamond exploration and mining. Exploration expenditures for diamonds in the region have increased almost 100 times. However, the poor infrastructure, long and severe winters, and high power costs associated with the Canadian Arctic present a particularly challenging environment for both exploration and mining activities. Therefore, it is especially relevant to study the economics of diamond projects in this northern environment.   The authors developed a hypothetical economic model using the discounted cash flow (DCF) method for diamond projects in the Canadian Arctic. The model reflects economic conditions applicable to the diamond mining industry in the Canadian Arctic at the present time. Economic and production data used for analysis are from company reports, mine plans, feasibility studies, pre-feasibility studies, and scoping studies of the operating mines and recent exploration projects. Data captured in the economic model include pre-production expenditures, production data, and post-production data.   The examination starts with base case analysis in both before- and after-tax scenarios, followed by sensitivity and break-even analyses using parameters including ore tonnage and grade, pre-production capital expenditure, operating cost, diamond price, and exchange rate. Economic indicators generated from the model include cash flow criteria, discounted cash flow (DCF) criteria, tax/royalty payments, and effective tax rates (ETRs). In addition, the relationship between tonnage and in situ value per tonne is also examined. The minimum acceptable combination of these two is constructed graphically based on the two assumed corporate internal rate of return (IRR) hurdles of 15% and 8%. Mining companies with different IRR hurdles could refer to the tonnage-in situ value per tonne relationship diagram when choosing their exploration targets.   The findings of the study are threefold: 1) Diamond projects in the Canadian Arctic are expensive to explore for and develop but can be economically robust under present conditions. They provide great economic return for mining companies and a significant amount of tax revenue for different tiers of governments. The hypothetical diamond project, in this study for instance, generates nearly $6 billion in revenue, almost $1.5 billion in profit, one-half billion dollars in NPV at 8%, and an IRR much higher than the current corporate required hurdle of 15%. In addition, it contributes about $1 billion in tax revenues for government. 2) The economic return of diamond projects in the Canadian Arctic is found to be highly sensitive to diamond price, ore grade, and the US dollar exchange rate, and less so to operating costs and even less so to tonnage and pre-production capital costs, suggesting that diamond exploration should focus on the ore grade and diamond quality reflected by price, and at the same time, monitor closely the US dollar exchange rate. 3) As diamond values/prices vary by qualities and locations, tonnage-in situ value per tonne, rather than the conventional tonnage grade used for metals, is recommended to be used as the criterion for the minimum acceptable exploration targets. The study found that an appropriate exploration target base in terms of tonnage need not exceed 20 million tonnes in the Canadian Arctic.   From the corporate perspective, the model provides the economics of a typical diamond project in the Canadian Arctic as well as guidance as to the minimum size and/or in situ value per tonne requirements of targets being sought in order to ensure economic success and predict exploration and development expenditures. From the government perspective, the model provides an indication of tax revenue and royalties that can be expected from a particular diamond project in the Canadian Arctic.