The sensitivity of greenfield mining project development, that is, the development of a mining business at a new undeveloped site, to macroeconomic changes is very high. Greenfield mining requires considerable funding before any revenues can be realized from the project. The feasibility of a project means its financial viability assessed via comprehensive evaluations. One of the most important factors impacting its feasibility is the interest rate that reflects the cost of financing. The rise in interest rates changes the basic economic calculation related to greenfield mining project development and may turn profitable projects unprofitable (Fontes et al., 2020).
The mining industry is one of the industries with a very high level of capital intensity. The rise in interest rates immediately leads to the increase in the Weighted Average Cost of Capital (WACC). WACC stands for the weighted cost of the firm’s equity and debt capital and serves as the minimum level of return that new projects need to exceed in order to create value (Dobrowolski et al., 2022). With the rise in interest rates, debt service costs grow, as well as returns on equity due to their opportunity cost.
A practical effect of high discount rate can be seen most vividly through the NPV (Net Present Value) of a project. The NPV is calculated by finding out the present value of future cash flows generated by the project and subtracting the capital invested from it. Greenfield mining projects entail long-term construction of the infrastructure before any ore production happens. Therefore, cash flows are generated much later in time. High discount rate decreases substantially the value of the delayed cash flows (Ovalle, 2020). It means that the mining venture that was very profitable at 5% discount rate may prove to be unprofitable at 10%.
Apart from the methods of valuation, there are direct limitations of debt financing in case of high interest rates. Banks that provide project financing turn out to be conservative about the risks associated with high interest rates. They increase the number of restrictions and reduce the amount of lending. Debt service becomes too expensive for the company due to the absence of income generation at the project construction stage. Therefore, the only way of financing is to provide more equity capital and dilute the shareholders’ equity. Junior mining companies often face the problem of unbankable greenfield projects.
To counteract these challenges to macroeconomic conditions, mining companies need to adapt their development models. Instead of implementing single-phase projects of a considerable size, mining companies turn to modular development models that help reduce the amount of capital investment at once and eliminate the immediate need to borrow money. Companies explore other sources of finance, such as joining joint ventures, arranging off-take agreements with downstream manufacturers for the upfront financing, and using streaming and royalties financing models (Jaroni et al., 2019). The purpose of such strategic moves is to avoid expensive financing.
In conclusion, high interest rates present a critical barrier from the perspective of macroeconomics that hinders the implementation of greenfield mine development projects. Through increasing the cost of capital, raising the discount rate, and decreasing the net present value of future cash flows, high interest rates quickly undermine any economic viability of projects under discussion. Debt becomes scarce and expensive, forcing companies to reconsider the project size and postpone development or seek other means of financing. Thus, in conditions of high interest rates, only the most profitable projects survive the tough scrutiny.
References
Dobrowolski, Z., Drozdowski, G., Panait, M., & Apostu, S. A. (2022). The weighted average cost of capital and its universality in crisis times: Evidence from the energy sector. Energies, 15(18), 6655. https://doi.org/10.3390/en15186655
Fontes, M. P., Koppe, J. C., & Albuquerque, N. (2020). Comparison between traditional project appraisal methods and uncertainty analysis applied to mining planning. REM – International Engineering Journal, 73, 261–265. https://doi.org/10.1590/0370-44672019730108
Jaroni, M. S., Friedrich, B., & Letmathe, P. (2019). Economical feasibility of rare earth mining outside China. Minerals, 9(10), 576. https://doi.org/10.3390/min9100576
Ovalle, A. (2020). Analysis of the discount rate for mining projects. MassMin 2020: Proceedings of the Eighth International Conference & Exhibition on Mass Mining, 1048–1064. https://doi.org/10.36487/acg_repo/2063_76
