MINERAL RESOURCES AND MINERAL RESERVES: THE CASE FOR INTERNATIONAL REPORTING STANDARDS
| Jurisdiction | United States |
Toronto, Canada
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Introduction
| TABLE OF CONTENTS | |
| 1. | MINERAL RESOURCES AND RESERVES |
| What are Resources and Reserves? | |
| Why are Mineral Reserves Important? | |
| 2. | THE NEED FOR A MODERN CODE |
| 3. | THE JORC SYSTEM |
| 4. | FEATURES OF THE JORC SYSTEM |
| Role of Professional Bodies | |
| Role of Competent Persons | |
| Mineral Resources and Mineral Reserves | |
| Application of JORC Codes | |
| 5. | UNITED STATES |
| Competent Persons | |
| Mineral Resources | |
| Mineral Reserves | |
| Commodity Price | |
| 6. | INTERNATIONAL HARMONIZATION |
| 7. | CONCLUSION |
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We are now more than three years into a global commodity-price boom and mineral exploration activity is being conducted at a rate not seen in over a decade. From 2004 to 2006, the Metal Economics Group estimates that mineral exploration spending increased 86% to US$7.1 billion, almost a fourfold increase from 2002 exploration expenditures.1 However, all mining companies, be they copper, nickel, zinc or gold producers, face the same reality; an asset base that is in a constant state of depletion. The discovery of deposits can make or break small exploration companies and are the pipeline that will ensure the continued success of large mining companies.
The role of securities regulators is to ensure that material information about an issuer and its business is not only reported in a timely manner but also in a language that can be understood by investors. To that end, National Instrument 43-101 -- Standards of Disclosure for Mineral Projects ("43-101") prescribes the manner in which a Canadian reporting issuer discloses material information arising from drilling programs in Russia (or any other country) to its security holders. However, should this issuer become a U.S. reporting issuer as well, thus becoming subject to U.S. securities regulation, there are material differences in the manner in which the same information is reported to the U.S. Securities and Exchange Commission (the "SEC").
The need for international standards was recognized long ago as a means to facilitate communication, create a common language and improve the quality of the information being released to the public by the mining industry.2 Information about mineral resources and reserves is a key measure of the value of a mining company and is used by investors to make investment decisions, by analysts for company valuations, by lenders for ratio calculations, by counterparties to hedging contracts and by rating
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agencies. For the issuers themselves, mineral resource and reserve information drive development decisions, mine planning and mergers and acquisitions.
The global convergence of accounting standards for the extractive industries will further accentuate the need for international mineral reporting standards. Consistency between Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) and securities laws with respect to reserve reporting is integral to financial reporting because the amount of reported "proven and probable" mineral reserves has a significant impact on the value of the company and on many financial statement measures, such as depreciation, amortization and impairment estimates.
Mining is a truly global marketplace and securities regulators have numerous incentives to promote harmonization of international reporting standards, particularly with the emergence of 'new' mining frontiers in the Far East and former Eastern Bloc countries, which have their own mineral codes. This paper will review the success that many of the most important mining jurisdictions have had in harmonizing their respective mineral codes. Following the adoption of the Australian JORC Code3 and its incorporation into the listing rules of the Australian Stock Exchange in 1989, Canada, the U.K., South Africa, Peru and Chile adopted similar JORC-style reporting codes. The United States has been the notable holdout in efforts to harmonize mineral reporting codes.
1. Mineral Resources and Reserves
What are Resources and Reserves?
Mineral deposits can be of a high grade or low grade; large scale (billions of tonnes) or a small scale (hundreds of tonnes); have a continuous or erratic distribution of mineralisation; at surface or up to 3 kilometers underground. Just as one cannot understand a company's financial statements without appreciating the accounting standards followed, one cannot appreciate the quality of a mining company's mineral properties without understanding the meaning of mineral resources and mineral reserves.
At the outset, it is important to appreciate that resource estimates are precisely that, estimates, not calculations. These estimates represent the reasonable opinions of experts about the nature of mineralization that is found below the surface. New information, a change in economic and other factors or a different geological interpretation can result in a material
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change to estimates. There is no single correct resource or reserve measure for a given deposit,4 particularly over a period of time.
To bring some order to a deposit, engineers, geoscientists and securities regulators have devised methods of classifying its mineralization according to (i) levels of geological confidence; and (ii) degrees of technical and economic evaluation. A "mineral resource" is essentially a concentration of material in such form and quantity and of such a grade that it has reasonable prospects for economic extraction. Mineralized material that does not achieve this basic threshold is of no interest for commercial production and is not quantified for securities law purposes.
The portion of a mineral resource that can in fact be economically mined at the time of estimation is called a "mineral reserve". Mineral reserves are demonstrated by detailed technical and economic studies (pre-feasibility or feasibility studies) that take into account realistically assumed mining, metallurgical, economic, marketing, legal, environmental, social and governmental factors. These studies must demonstrate at the time of reporting that extraction could reasonably be justified. Under the JORC-style reporting standards, both mineral resources and mineral reserves are further subdivided according to increasing levels of geological confidence.
Why are Mineral Reserves Important?
The manner in which mineral reserves are defined and measured directly affects an issuer's balance sheet and is among one of the most critical accounting and reporting issues for mining companies today.5 Under Canadian and U.S. GAAP, costs incurred in exploring for minerals may not be capitalized, since it is unclear at the exploration stage whether there is an underlying asset against which capitalized expenses might be amortized. However, once a portion of a mineral deposit attains the status of a mineral reserve, the deposit is treated as an asset and the exploration costs can then be capitalized, as future cash flow will support the recoverability of any exploration costs deferred. The SEC staff has taken the position that it will generally challenge capitalization of exploration costs by mining companies until mineral reserves are established in accordance with its Industry Guide 7, Description of Property by Issuers Engaged or to be Engaged in Significant Mining Operations ("Industry Guide 7").6
Consequently, changing the definition of mineral reserves will directly affect a company's bottom line by determining whether exploration dollars
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are expensed or capitalized and modifying depreciation, depletion and amortization schedules as well as asset impairment tests. If a definition is too restrictive, it can understate earnings in the current year and overstate earnings in future years, once the mine is in production.
Given the importance of U.S. markets, many mining companies find themselves, deliberately or inadvertently,7 subject to SEC requirements, including U.S. GAAP or U.S. GAAP reconciliation.8 Application of U.S. GAAP requires, in turn, application of the SEC's Industry Guide 7. For example, when Kinross, TVX and Echo Bay entered into a three-way merger agreement in 2002, the Canadian GAAP pro forma financial statement included in the proxy circular contained an extensive note reconciling these financials to U.S. GAAP. The higher threshold for mineral reserve classification under Industry Guide 7 meant that C$2.2 million in capitalized development costs and C$2.1 million in amortization against 43-101 reserves had to be reversed and treated as exploration expenses for U.S. accounting purposes, as the reserves did not exist under U.S. rules. Before there can be an international accounting standard on financial reporting in the extractive industries, an international standard on what constitutes a mineral reserve is required.
2. The Need for a Modern Code
The unique challenge that any regulator faces with extractive industries (mining, oil and natural gas) is that the asset base of these companies is underground and cannot be readily verified. Attempts to establish reporting standards for minerals have been traced back to 1556, when Georgius Agricola published De Re Metallica, which described in detail mining methods, smelting and metallurgical processes, geology, mineralogy, and mining laws of the day. Agricola's contribution to the sciences of geology and mine engineering was unsurpassed for 180 years, until Schlüter's book on metallurgy was published in 1738. In 1909, before becoming President of the United States, Herbert Hoover published Principles of Mining, laying the foundation for our modern classification systems. In 1980, the United States Geologic Survey...
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