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Interpreting a Mining Cost Curve 102: the Assumptions

Updated on June 4, 2013

Interpreting a Mining Cost Curve 101: the Basics looked at the primary features of the Cost Curve and described the demand line. In 102 we are going to look at three of the main assumptions behind the Cost Curve – so that you can apply it correctly and in the correct situations.


THE ENTIRE MARKET

The primary assumption behind the Cost Curve is that it accurately represents the entire market that miners and consumers participate in. If consumers can access the commodity from another miner not included in the Cost Curve, the market price will respond in a different manner to supply and demand changes than what we expect from the Cost Curve. This makes the development of a Cost Curve incredibly difficult as no miner that serves a market, or potentially serves a market, in the case of mines on care and maintenance, can be left out. This requires that a number of estimates are included in any Cost Curve – see Is China’s Domestic Iron Ore Cost Curve Lower Than Expected?


LIKE PRODUCTS AND LIKE COSTS

The miners on the Cost Curve needs to be producing the same, or at least a fairly similar product, and/or adjusted accordingly. In particular, products need to …

Be shipped to the same place. For bulk commodities you really need to construct/(analyse) the Cost Curve on a Cost Insurance Freight (CIF) or Cost Freight (CFR) basis as transport costs can be a significant portion of total cost. You cannot compare Free On Board (FOB), CIF and CFR costs without making adjustments – you are comparing apples and oranges. This is less important for precious metals or products where transport is a small portion of their total cost, where you might even be able to compare production on a FOB or at the gate cost basis. You may also want to read a glossary of international shipping terms.

Include similar costs. You need to ensure that costs are calculated on the same basis and include the same items. Some Cost Curves will include depreciation and non cash items, while others will only include cash costs.

Have similar grades and impurities. Typically, the Cost Curve will be based on a contract such as the 62% Fe, CFR Tianjin iron ore contract. Adjustments will need to be made to any product that does not fit the contract specifications. (You also need to ensure that you are comparing the same unit of mass.) Read some of the physical specifications for metals contracts on the LME website.

Include substitutes. If there is a substitute for the commodity being analysed it may need to be placed on the Cost Curve and adjusted accordingly. Although, substitution may only occur in price ranges where there is no economic difference between the two products. For instance, molybdenum and vanadium can be substituted for niobium in some cases - but approximately twice the amount is required. Therefore, an adjustment for the cost of producing 2kg of molybdenum or vanadium would need to be undertaken and then molybdenum and vanadium could be placed on the 1kg, niobium Cost Curve.


A POINT IN TIME

The Cost Curve only reflects costs of production and supply at a point in time. The nature of markets means that supply and costs are always changing and a Cost Curve is only accurate until it changes - there is significant uncertainty involved. However, the Cost Curve is an excellent framework to explore supply and demand uncertainty and run scenarios to:

  • Examine investments and expansions and their impact on price and profits; and
  • Analyse strategic incentives for game theory and strategy applications.


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