Analysts seem to be falling over themselves to explain the causes and consequences of the low oil price which is still trading below $60 per barrel as of today. As we are predominantly focusing on the precious metals sector, we are obviously very interested to see what the effect of a lower oil price is on the price of gold and the financial performance of gold mining companies.
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If we look at the charts, the gold/oil ratio has increased incredibly fast to a ratio of around 22, coming from just 13 in early October. The Relative Strength index shows the ratio to be in an ‘overbought’ territory which could very well mean that the ratio will come off a bit, either by a lower gold price (not very likely) or an increase in the oil price (which is already more likely).
This isn’t a unique situation though. Even though the oil price is indeed trading at its lowest level in approximately five, six years, we don’t have to look that far back in time to find a higher Gold/Oil ratio. Just two years ago, at the end of 2012 we also had a ratio in excess of 20, so the 2012-2014 period could be seen as an abnormality which can be seen on the next chart as the Gold/Oil ratio has been trading at its lowest point in six years time.
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As gold-focused analysts, we are obviously also extremely interested to know the impact of this oil price on the production cost of gold. And that’s where we enter dark and unexplored territory as there’s virtually no information about this topic. That’s understandable as every mine has its own needs depending on a zillion of factors of which the most important factor obviously is whether or not the mine is located close to a ‘civilized’ area.
As the average energy consumption to produce a kilo of gold is between 150 and 300 Gigajoules [8] , the mining sector obviously is a sector with an extremely high consumption of energy and the fate of a project could be decided by whether or not it could be hooked up to an existing power grid. This has obviously put companies operating in remote areas at a disadvantage compared to other mining operations. Agnico Eagle’s Meadowbank mine in Nunavut, for instance, has no access to the power grid and all diesel fuel needs to be hauled in. At a consumption rate of 200,000 liters of diesel per day, you’d think the impact of a lower oil price would be noticed by Agnico Eagle. This is theoretically true, but as the mine is operating quite far up north, the company needs to make sure it has a sufficient amount of fuel before the winter kicks in. As the oil price only started to slide in October, it sure looks like Agnico has purchased its ‘winter fuel’ for the Meadowbank mine right before the oil price crash and is stuck with the higher cost fuel.
The effect for African and South American mining companies will be much higher as those aren’t really depending on stocking fuel for the season. As the power supply on the existing grids is also highly unreliable, the best option for African gold producers is to buy diesel generators. For instance Endeavour Mining’s Tabakoto mine (which will produce 150,000 ounces of gold this year) is fully depending on the electricity generated by diesel fuel. The cost of power is thus relatively high at $0.25/KWh which compares quite bad with for instance Detour Gold which pays $0.055/KWh as the company is operating in Canada and connected to the power grid. The Tabakoto mine plan took a diesel cost of $1.09/l into consideration at a time when the oil price was trading around $100 per barrel. There’s an automatic correction system in place in Mali so the fuel price goes down at a slower rate than the oil price. So if we would now take a 15% lower diesel price into consideration, that would save the company roughly $0.16 per liter.
As that specific operation needs 35-40 million liters of diesel per year, the annual savings because of the lower oil price could easily be $6M. This doesn’t sound like much, but for a relatively low-margin operation, producing 150,000 ounces per year, that’s a saving of roughly $40 per produced ounce. That’s 40 dollars being shaved off the all-in cost per ounce and will directly impact the bottom line as well. The same numbers apply to Nevsun Resources, another Africa-focused diesel-powered mine which is producing copper.
And it’s not just Africa. Large-scale operations such as Barrick Gold’s Cortez Hills or Pipeline mines in Nevada which is using some of those gigantic trucks to haul ore and waste rock around. These trucks consume on average 700 liters of fuel per hour, or roughly 15,000 liters per day. This means that with a fuel cost being reduced by $0.20/l, Barrick could save approximately $3,000 per day, per truck. As Barrick will deploy roughly 50 trucks, the total saving is approximately $55M per year. And this only takes the big trucks into consideration and ignores all the other equipment so the total savings per year will be in excess of $75M. Again, this goes directly to the bottom line of the earnings report.
We have the impression the impact of the lower oil price on the gold mining sector is (conveniently) being ignored by the market, and that’s where you could have an advantage which proves the theory of efficient markets is effectively dead. We are expecting the ‘remote’ gold projects which are running on diesel fuel to show (much) better than expected operating results due to the lower oil price resulting in a lower (diesel) fuel price. We are excited about this development and you should be too as the operating expenditures will go down resulting in an increased profit margin.
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