Most open-cast mines require the removal of overburden and waste material to access the underlying orebody. This activity is known as ‘stripping’. By their nature, all open pits become narrower with depth, and consequently the volume of waste to be stripped is largest on the upper benches that must be mined first. The problem is mitigated by phasing of pit development (‘push-backs’) which allows stripping of some near-surface waste to be deferred until closer to the time when the ore it is covering will be extracted. Nevertheless, there is often a timing difference between incurring the cost of stripping and the benefit obtained when the ore is processed. Incurring losses in the early years of a project only to recoup that profit in later periods gives a distorted view of the overall economics of a project, and accounting rules will therefore allow stripping costs to be capitalised, with that asset then being depreciated as an operating expense evenly over the mine life.
It is important to note that, although capitalization has no impact on pre-tax cash flow tax authorities also recognise the need to capitalize development (stripping) costs. Jurisdictions vary both in the extent to which costs can be capitalized and the manner in which the resulting allowances are used, and to this extent the capitalization of stripping can impact after-tax cashflows.
Typically, during initial mine development, prior to production commencement, the stripping cost relating to (a component of) the orebody, forms part of the CAPEX to develop the mine. As such the stripping cost can be depreciated, similar to the other development CAPEX, for example the process plant CAPEX. [Note: A “component” is a subsection of the orebody that has a distinct useful economic life, to which access has been provided through stripping. For example, ore exposed by an individual push-back].
Where multiple pits are mined separately, the respective initial stripping costs may be accounted for individually as CAPEX. However, when pits are integrated, the stripping costs for the second and subsequent pits are often deemed to be extensions of the initial pit. As such, while the costs to remove the “initial” overburden can be capitalised, waste from subsequent pits would then be classified as production phase stripping and expensed as the costs are incurred.
Deciding whether multiple pits are mined separately or as an integrated (single) operation depends on each mine’s unique circumstances. Generally, if the following factors apply, then most likely the stripping costs of the individual pits can be accounted as separate mine development CAPEX:
- mining the subsequent pits consecutively, rather than concurrently, to the initial pit;
- the decision to develop each pit is made distinctly, rather than as a single investment decision during commencement of the initial pit;
- mine planning and operating of the pits and the sequencing of overburden removal and ore extraction is performed as separate units rather than an integrated unit; and,
- expenditure for additional infrastructure to support developing each subsequent pit is relatively large.
An additional point to consider is if the designs of the subsequent pits are influenced by opportunities to optimise extraction from other pits, such as ore blending, then this would indicate the requirement to treat the initial stripping cost as an integrated operation. Then, as discussed, only the initial stripping cost of the first pit can be capitalised.
Production phase stripping cost can also be capitalised if the following three criterial hold true:
- a future economic benefit will occur since stripping has provided access to the orebody;
- the orebody “component” for which access has been provided can be identified; and,
- it is possible to accurately measure the costs associated with the stripping activity.
Production phase stripping can yield two benefits. Firstly, it provides access to ore for extraction during the current period. Secondly, it provides access to future ore. The stripping cost associated with the current period is expensed during that period and the stripping cost associated with the future benefit is deferred i.e. is classified as CAPEX, creating a Deferred Stripping asset.
Where the stripping cost to provide “future ore” and “current ore” cannot clearly be separated, the stripping cost may be allocated by applying a (relevant) production measure and an average strip ratio over the component’s life. A relevant production measure might be the amount of ore mined or “units of production” – based on the expected recoverable metal in the ore, unless a more appropriate method exists.
The possibility exists that subsequent stripping phases (in future) will access additional ore and that these subsequent future phases are only possible after the initial phase. In this instance, the mining company should consider on a case-by-case basis whether the subsequent stripping cost is to be expensed as OPEX or should be capitalised.
Micon’s mining engineers are skilled at scheduling open pit stripping to optimize NPV while meeting the constraints of fleet and process plant capacity. Our mining economists will take jurisdictional tax policy into account when evaluating a project. For operational tax planning, though, please seek the advice of professional mining tax specialists.