The Economic Aspect of Geology Part 35

DEVELOPMENT AND EXPLOITATION OF MINERAL DEPOSITS

The search for new ore bodies is closely related to the development, extension, and mining of ore bodies already found. In this field the geologist finds wide application of his science. Here he may not be so much concerned with the economic factors or with the broader methods of geologic elimination; his study is more likely to be based mainly on the local geologic conditions.

Some of the larger and more successful mining companies, perhaps the greater number of them these days, have geologists whose business it is to follow closely the underground operations, with a view to advising on the conduct of the development work. This requires the most precise and intensive study. For instance, the Anaconda Copper Mining Company has a staff of several geologists, who follow the underground work in the utmost detail and whose approval must be obtained by the operating department in the formulation of any development plan. The complexity and fault relations of the veins in this company's mines are such that the application of these methods has abundantly justified itself on the cost sheet.

Too often mining companies leave the planning and execution of the underground development work to the local management, commonly to the underground mining captain, without geologic consultation. This procedure does not eliminate the economic geologist; for when the development fails at any point, or new and unexpected conditions are met, the geologist is likely to be called in. In such cases the practice of a geologist is like that of the ordinary medical pract.i.tioner; he is called in only when his patients are in trouble. The use of adequate geologic advice in the planning stages is about as little advanced in some localities as the practice of preventive medicine.

The work of the economic geologist may not be ended by the finding and development of the ore; for the moment this is accomplished, he should again consider the economic phases of the problem--the grade of his ore, its probable amount, and other features, in relation to the general economic setting. In his enthusiasm for physical results, he may be carried into expenditures not justified by the economic factors in the problem. Some one else may and usually does look out for the economic elements, but the prudent geologist will at least see to it that someone is on the job.

FOOTNOTES:

[37] Smith, George Otis, and others, The cla.s.sification of the public lands: _Bull. 537, U.S. Geol. Survey_, 1913.

[38] Schlumberger, C., _Study of underground electrical prospecting_: Translated from the French by Sherwin F. Kelly, Paris, 1920.

Bergstrom, Gunnar, and Bergholm, Carl, "Teknisk Tidskrift, Kemi och Bergvetenskap," 1918, Book 12.

[39] Hoover, Herbert C., _Principles of mining_: McGraw-Hill Book Co., New York, 1909, p. 32.

[40] Leith, C. K., Use of geology in iron ore exploration: _Econ.

Geol._, vol. 7, 1912, pp. 662-675.

[41] Van Hise, C. R., and Leith, C. K., Geology of the Lake Superior region: _Mon. 52, U.S. Geol. Survey_, 1911.

CHAPTER XV

VALUATION AND TAXATION OF MINERAL RESOURCES

POPULAR CONCEPTION OF MINERAL VALUATION

The total returns from mining may not in the aggregate be far above the expenditure for exploration, development, and extraction; yet the total mineral wealth of the United States, on the basis of earning power and aside from the industries based on it, cannot be far from sixty billions of dollars, and this wealth has virtually come into existence since the 1849 gold rush to California. The mining industry supports a large population. These facts are the solid basis for the widespread popular interest in mineral investment--and mineral speculation. But there are other reasons for this interest,--the gambler's chance for quick returns, the "lure of gold," the possibility of "getting something for nothing," the mushroom nature of certain branches of the industry, the element of mystery related to nature's secrets, and the conception of minerals as bonanzas with ready-made value, merely awaiting discovery and requiring no effort to make them valuable. In the United States a factor contributing to the popular interest is the large freedom allowed by the laws to discover and acquire minerals on the public domain.

Perhaps no other field of industry comes so near being common ground for all cla.s.ses of people. The mineral industry is a field in which it is easy to capitalize not only honest and skillful endeavor, but hopes, guesses, and greed. It is not to be wondered at, therefore, that in the popular mind the valuation of a mineral resource is little more than a guess, and sometimes not even an honest one.

Nevertheless, the mineral industry has become second only to agriculture in its capital value and in its earning capacity. In this industry it is hardly possible to arrive at valuations as securely based as in many other industries, but the elements of hazard are not so hopeless of measurement as might be supposed. The great mineral and financial organizations do not depend on mere guesses, but use well-tried methods.

If the general investor were to give more attention to these methods he would doubtless save himself money, and the mineral industry would be rid of a great inc.u.mbrance of parasites who live on the credulity of the public. To anyone familiar with the mineral field, it is often surprising to see the rashness with which a conservative business man, who would not think of entering another industrial field without close study of all the factors in the situation, will invest in minerals without using ordinary methods of a.n.a.lysis of values.

In the following account of valuation of minerals in the ground, and the closely related subject, taxation of such minerals, the attempt is made to state some of the principles briefly and simply with a view to making them intelligible to the layman. Values beyond the mine are concerned with so many factors of a non-geologic nature that they are not here discussed.

VALUATION AND TAXATION OF MINES

INTRINSIC AND EXTRINSIC FACTORS IN VALUATION

It is essential to recognize at the outset that the value of a mineral deposit, like the value of any other commercial material, comprises two main elements; an intrinsic element based on the qualities of the material itself, and an extrinsic element based on its availability and the nature of the demands for it. The two elements may not be sharply separated, and neither exists without the other. A mineral deposit in easy reach of a populous community, which has sufficiently advanced methods and requirements to use it, may have high value; an exactly similar deposit, if far removed from points of consumption, handicapped by transportation, or available only to people without developed methods for its use, may have little or no value. Intrinsically the deposits are alike; but extrinsically they are far different, and their values are correspondingly unlike. Even two adjacent properties, differently managed and controlled, and with different relations to markets, may have somewhat different values depending on the use made of them. The value of a deposit may vary from year to year with changes in demand for its output, or with changes in metallurgical and other processes which make its use possible. Minerals of small bulk and high value, as for instance gold, platinum, and diamonds, have a nearly standard value related to their intrinsic properties, because they can be transported so easily to any part of the world. On the other hand, materials of large bulk and low unit value, such as coal, iron ore, and clay, may have highly varying values independently of their physical characteristics, because of their relative immobility. But the values even of gold and precious stones represent a combination of intrinsic qualities and of demand. A diamond is made of carbon but is more valuable than coal or graphite because it appeals to the esthetic taste.

It is only because man introduces an element of demand that the diamond takes on value. In short, man is the multiplier and the mineral substance is the multiplicand in the product known as value.

Recognition of the two elements of value is vital to a clear understanding of the methods and problems of valuation of minerals. It is too often a.s.sumed that the physical properties const.i.tute the sole factor.

Looked at in a large way, the returns from the mineral industry are commensurate with the effort put into discovery and development of mineral resources, even though the returns to lucky individuals have been excessive. In respect to the importance of the human energy element, the mining of minerals is not unlike the cropping of soils.

Some interesting economic studies have been made of mining districts to ascertain whether the total return has been equal to the total investments by both successful and unsuccessful partic.i.p.ants. The results show that, even in some of the most successful districts, there is not a large "social surplus,"--that is, a surplus of receipts over total expenditures. It is difficult to generalize from such studies with any degree of accuracy; but it seems likely that if we could measure the vast amount of fruitless effort which has been expended in non-productive territories, the result would tend to bear out the general conclusion that the social surplus for the mineral industry as a whole is a modest one, if it exists at all. Of course, it is to be remembered that the total benefits from mineral resources are not to be measured in terms of gain to the producers,--but that their measurement must take into account the satisfying of all the complex demands of modern civilization.

VALUES OF MINERAL DEPOSITS NOT OFTEN ESTABLISHED BY MARKET TRANSFERS

While minerals as extracted and used may have standard market values, mineral deposits in the ground are not bought and sold on the open market with sufficient frequency to establish standard market values. A sale may establish a criterion of value for the particular deposit, but not for the cla.s.s of deposits,--for no two mineral deposits are exactly alike. Stock quotations may establish a certain kind of market value, but these are often vitiated by extraneous considerations. For these reasons the valuation of a mineral deposit is in each case a special problem.

THE AD VALOREM METHOD OF VALUATION

The ordinary commercial method of valuing mineral deposits recognizes the two main elements of value above discussed. This method is sometimes called the _rational_ or _ad valorem_ method. The profit per ton (or per other unit) of the product is established, on the basis either of past performance of the property or of experience with other similar properties. This profit is multiplied by the total tonnage estimated in the deposit, the estimate including known reserves, probable reserves, and in some cases possible and prospective reserves. The product of the profit per ton and the total tonnage gives the total net amount which will be received; it does not, however, give the present value, because the commodity cannot all be taken out and sold at once, but must be mined and absorbed by the market through a considerable period of years.

The returns receivable some years in the future have obviously a lower proportionate present worth than amounts to be received at once. The interest rate comes into play, making it necessary to discount each annual payment for the number of years which will elapse before it is received. It is evident, therefore, that an estimate of the _life_ of the property is necessary, involving not only knowledge of the reserves, but also a forecast of the annual extraction or _rate of depletion_.

As a simple case of _ad valorem_ valuation for ill.u.s.trative purposes, a deposit containing 1,000,000 tons in reserve has an estimated output of 100,000 tons a year for ten years, on which the profit per ton has in the past averaged $1 and is expected to average $1 in the future. Ten annual instalments or dividends of $100,000 are to be received. The present value of the total of these instalments is figured by an annuity method. It is the value upon which the series of dividends will pay interest at a predetermined rate, in addition to paying to a sinking fund annual instalments which, safely invested each year at a low rate of interest (usually 4%), will repay the present value at the end of the ten years. In our hypothetical case, if an interest rate of 8% be taken, the present value of $1,000,000, to be received through ten years in ten equal instalments, is $612,000. In other words, the sum of $612,000 will be replaced by the sinking fund at the end of ten years, and will pay 8% interest during this period,--this requiring total receipts of $1,000,000 in ten equal annual instalments. If the deposit here cited as an ill.u.s.tration were to be worked out in three years, thus yielding three annual instalments of $333,000, its value would be $833,000.

Each of the factors entering into this method of valuation covers a wide range of variables, any one of which may be difficult to determine.

The profit per ton for a given deposit may have been extremely variable in the past, making it difficult to determine whether the highest or lowest figure should be projected into the future or whether some average should be taken; and if an average, whether the time covered by the average should be long or short. For a small, short-lived deposit obviously the most recent conditions would be taken into account in estimating future profits. For a long-lived property there would be more tendency to consider the long-time average vicissitudes, as reflected in the average profits of the past. For some mineral commodities there are cycles of prices, costs, and profits, of more or less definite length, established during the long past history of the industry; and in such cases it is desirable in calculating averages to use a period covering one or more of these cycles, rather than some shorter or longer period.

For many minerals, however, these cycles have been too irregular to afford a sound basis for future estimates. If the experience of the property itself is too short to afford a sufficient foundation for forecasting profits, or if there has been no previous work on the property, then it is necessary to use averages based on other properties or other districts; or if there are none strictly comparable, to build up a hypothetical figure from various estimated costs of labor, supplies, and transportation, selling prices, etc. In the estimate of the profit factor, the geologist is not primarily concerned.

In estimating the total reserves in a mine, geological considerations nearly always play a large part. An ore body may in some few cases be completely blocked out by underground work or drilling, eliminating the necessity for inferring conditions beyond those actually seen; but in the huge majority of mineral deposits the reserves are not so definitely known, and it becomes necessary for the geologist, through knowledge of similar occurrences, through study of the structural features of the deposit, its origin, and its history, to arrive at some sort of an estimate of reserves.

In estimating the life of a mineral deposit it is necessary to start with the figure of total reserves, and from a study of conditions of mining and of markets to estimate the number of years necessary to exhaust the deposit. This is a more nearly commercial phase of the problem, in which the geologist takes only part of the responsibility.

Perhaps more estimates of value have gone wrong because of misjudgment of this factor than for any other cause. If the physical conditions are satisfactory, it is easy to a.s.sume a rate of extraction and life based on hope, which experience will not substantiate.

The choice of the interest rate to be used in discounting future receipts to present worth likewise is a financial and not a geologic matter. Again, however, the geologist must give consideration to this factor, in view of the fact that the interest rate must be varied to cover the different degrees of hazard and doubt in the geologic factors.

For instance, to the extent to which the estimate of ore reserves is doubtful, it is necessary to use a high rate of interest to allow for this hazard. In a large, well-developed mineral deposit, with the geological factors all well known and the demand and market well established, it is reasonable to use a lower rate of interest. In general, the mineral industry is regarded in financial circles as being more hazardous than many other industrial lines; and money is put into the industry with the expectation of a high rate of interest, no matter how safe the investment may be. In actual practice interest rates used in making valuations vary from 6 to 15 or 20 per cent.

It is clear that, where a property has long life, the interest will very materially reduce the present value of the ores to be mined far in the future. Reserves to be mined more than thirty years hence have relatively little or no present value. Beyond a certain point, therefore, the acquirement and holding of reserves for future use by private companies has little commercial justification. This is a matter which is too often not sufficiently well considered. Man's natural acquisitiveness often leads him into investments which, because of the time and interest factor, have little chance of successful outcome. Of course a large corporation, antic.i.p.ating an indefinitely long life, or perhaps aiming at monopoly, may afford to hold reserves as a matter of general insurance longer than a small company,--even though, because of the interest rate, these reserves have no present value on their books.

It is likewise true that governments, looking forward to the future of the nation, and without the necessity of paying so much attention to interest and taxes, are not so limited by this consideration.

An ill.u.s.tration of the limiting effect of the interest rate on the acquirement of long-lived coal deposits by private interests is discussed in Chapter XVII on Conservation. Investments made many years ago have so augmented, even at low interest rates, as to make it practically impossible to count on a return of capital and interest; or if the return were to be exacted from the public it would mean excessive charges, which are not possible in compet.i.tion with other mines not so burdened.

In the commercial valuation of oil wells and pools, much the same method is used as has been described for mineral resources in the solid form, but the estimate of reserves or life is based on consideration of curves of production of the sort mentioned on pages 134-136.

The essence of the _ad valorem_ method of valuation above described is income-producing capacity. This method recognizes the fact that the value of the mineral deposit depends, not only on its physical const.i.tution, but also on what performance can be expected from it.

Stock quotations on mineral properties in the standard markets are based substantially on estimates of income capacity, more or less on the _ad valorem_ basis. However, the quotations also reflect the hopes and fears of the public, often resulting in valuations quite different from those based on studies of the objective conditions.

The war introduced new considerations into the problems of _ad valorem_ valuation. Under peace conditions there is a tendency toward the establishment of normal costs, selling prices, and markets, which can be taken more or less for granted by anyone attempting to value mineral deposits. Under war and post-war conditions, few of these elements can be taken for granted; it becomes necessary to consider the entire world situation in regard to a mineral commodity, the effects of the Peace Treaty (which greatly concerns minerals), future international relations, tariffs, and other matters of a similar sort. If a person were today valuing a manganese deposit according to the method above outlined, and were to confine himself solely to a narrow consideration of past markets and profits on individual properties, he would be very likely to go wrong,--for the world manganese situation has an immediate and practical bearing on each local problem (see pp. 173-176).

OTHER METHODS OF MINERAL VALUATION AND TAXATION

We have discussed the _ad valorem_ method of valuation at some length because it is the one in widest commercial use, and also because the principles involved underlie practically all other methods of mineral valuation. The _ad valorem_ method is used in appraisals for taxation in some districts and for some commodities, as, for instance, the iron mines of Michigan and Wisconsin. Its application, however, requires skill and judgment if equitable results are to be secured. For taxation purposes, therefore, it is not uncommon to adopt purely arbitrary or empirical methods which eliminate the element of judgment, and which often result in valuations quite different from those used commercially.