The economic component in planning a mining enterprise and consequences for the investor

Despite the war, business in Ukraine is functioning, building strategies, and investing funds. Notably, a significant portion of the revenues to the state and local budgets consists of taxes from subsoil users and rental payments for the use of subsoil resources.

How much money did the state receive last year?

Throughout 2023, the State Service of Geology and Subsoil of Ukraine team prepared new objects for electronic trading, announced and conducted auctions, and issued special permits for the use of subsoil. Similarly, subsoil users had the opportunity to submit their proposal for the auction.

According to the State Service of Geology and Subsoil of Ukraine, during the last year – 2023, Ukraine issued 465 special permits for the use of subsoil, which is 58% more than the year before. The fee amount reached a record 2.4 billion hryvnias, of which 75% were revenues obtained as a result of conducting electronic trades at auctions.

How is the sale of special permits conducted?

In Ukraine, the right to use subsoil is regulated by the Code of Subsoil and other relevant legal acts. Companies wishing to extract minerals are required to obtain such a permit, in most cases, by purchasing at an auction through the Prozorro.Sales system.

The initial cost of a special permit for the use of subsoil, which is put up for auction, is calculated based on the Methodology for determining the initial price of sale at an auction (electronic trading) of a special permit for the right to use subsoil, approved by the Cabinet of Ministers of Ukraine resolution from October 15, 2004, No. 1374.

If a mineral deposit, whose reserves have been approved by the State Commission of Ukraine on Mineral Reserves and recorded in the State Balance of Mineral Resources, is put up for auction, then the cost of such a permit directly depends on the volume of such reserves and their value (units of value of commodity production, published quarterly on the State Service of Geology and Subsoil of Ukraine website).

The contours of such deposits, put up for auction by the State Service of Geology and Subsoil, are determined as of the date of the reserves calculation, which often dates back to the 70s-80s of the last century when the ecological aspect was not considered in the assessment of reserves, often such deposits were evaluated in riverbeds and riparian buffer zones.

What is important for subsoil users?

Ukraine, as a country with developed mining potential, has a significant system of legal and economic aspects related to the use of subsoil. The sale of special permits for the use of subsoil is a key stage for mining enterprises and their investors who wish to exploit the country’s resources. However, planning a mining enterprise requires not only obtaining permits but also careful analysis of reserves and their reality, as this directly affects the investment attractiveness and profitability of the project.

Analyzing these figures, we see that the dynamics regarding the amount of funds received from the sale of special permits (SD) are increasing, but there is another side – the result that the business receives. After all, not in all cases can the business achieve the expected outcome. This is especially true for the amount of reserves declared and what actually exists (or what the subsoil user can legally extract).

Economic component in planning a mining enterprise

Planning a mining enterprise includes the evaluation of mineral reserves. However, when calculating potential reserves, it is necessary to consider not only their volume but also the quality, geological conditions, and the technical complexity of extraction. Underestimating or overestimating reserves can affect the commercial effectiveness of the project.

Consequences for the investor when expected reserves do not match reality

If the actual mineral reserves do not meet expectations, it can have serious consequences for investors. Specifically, investors may face financial losses due to expenses on purchasing the special permit, geological information, exploration, development, which may not be covered by low volumes of production.

In conclusion, investing in the mining industry in Ukraine and planning a mining enterprise are complex processes that require careful analysis, thorough planning, and awareness of many aspects. Considering the real reserves and their impact on commercial effectiveness is key to the successful implementation of projects and preventing potential financial risks for investors.

Auctions for the sale of special permits for the use of subsoil are of great importance for the development of the mining sector and attracting investments to the country. However, there are a number of risks associated with such auctions that can affect the trust in the permit sale process and the state overall. Among these risks are:

Incomplete information on subsoil. If the information provided or published regarding the subsoil is insufficient, this can lead to incorrect or distorted assessments of the potential value of resources. Investors may lose trust in the auction process and refrain from participating.

Environmental and infrastructure risks. The State Service of Geology and Subsoil (Derzhgeonadra) conducts the sale of permits without assessing the impact on the environment (Environmental Impact Assessment, EIA). This responsibility is placed on the subsoil user in the future. The auction documentation package does not include information on possible environmental restrictions. This may lead to a discrepancy between the amount of mineral reserves stated in the special permit and the volume that can be extracted during the operation of the deposit.

Analyzing projects that were put up for auction, we see that, for example, the Pidmykhaile plot of the Kalush gravel-sand deposit has a number of environmental restrictions that do not allow the full development of the area.

Initial characteristics of the Pidmykhaile plot:

Area: 23.59 ha.

Reserves: 1,386 thousand cubic meters.

Enterprise supply term: 27.6 years.

Initial sale price: 887,549.21 UAH excluding VAT.

During the preliminary project monitoring, it was established:

In the northern part of the special permit for the use of subsoil of the Pidmykhaile plot of the Kalush deposit, the Limnytsia River flows, and according to Article 80 of the Water Code of Ukraine, to protect the water regime of small rivers, it is prohibited to carry out works that can negatively affect or affect the water regime of the river and the quality of water in it. The river’s catchment area is 1580 km². According to Article 79 of the Water Code of Ukraine, the river is considered small, as its catchment area is up to 2 thousand km². The coastal protective strip of the Limnytsia River, in accordance with Article 88 of the Water Code of Ukraine, should be 25 meters.

However, the river is an object of the natural reserve fund – a landscape reserve of local importance “Limnytsia River with a protective strip along the banks 100 meters wide,” so the coastal protective strip is not 25 meters but 100 meters.

In the southeastern part of the plot, the sanitary protection zone is not maintained, and public buildings are located in close proximity to the deposit’s contour.

The operational calculation of the remaining areas and reserves is as follows:

Plot 1: area 4.6 hectares, reserves 298,789 m³.

Plot 2: area 2 hectares, reserves 132,502 m³.

Thus, as a result of the pre-project monitoring of the Pidmykhaile plot of the Kalush deposit, taking into account all restrictions, it was possible to establish the following:

• The plot cannot be worked as a single quarry but is divided into 2 parts.
• The area that can be developed is only 6.6 hectares, which constitutes 27% of the area put up for auction. The operational reserves amount to 431,291 m³ with an average thickness of the mineral of 6.35 m, which constitutes 31% respectively.
• The term of supply for the enterprise, at the annual capacity provided in the initial parameters – 50 m³/year, is only 8.6 years.

The real value of the plot according to the Methodology for determining the initial sale price at auction (electronic trading) of a special permit for the right to use subsoil, by the volume of the mineral that can be extracted and sold, amounts to 250,822 UAH.

From the example above, it can be seen that when deciding to pay for the cost of a special permit, which increases during the auction, in the case of the Pidmykhaile plot, it increased by 1816%, to 16,120,000 UAH. Investors must understand the real quantity of reserves that can be legally extracted and their actual cost price because, in addition to the special permit for the use of subsoil, additional investments are required for design, environmental impact assessment, land allocation, related permits, etc.

Unfortunately, many similar cases can be cited. That’s why it’s important for investors to thoroughly analyze the conditions of the auction and permits for the use of subsoil, as well as to consider legal and economic risks before participating and as a result of the auctions.

What subsoil users can do to avoid problematic assets?

When Derzhgeonadra puts a plot up for auction, it checks for overlaps with other permits for the use of subsoil and registered third-grade forms. Separately, plots where the type of subsoil use is geological study, including pilot-industrial development of minerals with subsequent extraction, are sent a package of documents for approval to the Ministry of Environmental Protection and Natural Resources of Ukraine.

However, as we see from our experience analyzing subsoil plots and deposits that have been put up for auction, the best way to protect a business from purchasing an unprofitable asset is to conduct a thorough check before deciding to participate in the auction. Pre-project monitoring takes into account geological, environmental, and other aspects that could affect the development of the deposit and allows the subsoil user to get an overall picture of all environmental restrictions, prohibitions in the planned activity area and its impact zone, an approximate amount of operational reserves of minerals, etc.

Thus, with the help of experts who analyze all necessary data, you can confidently start investing in the project.

What pre-project monitoring consists of?

Conducting pre-project monitoring is an extremely important stage in the development of a business plan for any mining project, especially when considering the possibility of developing reserves of a deposit that are put up for auction for special permits for the use of subsoil. Pre-project monitoring allows investors and mining companies to assess the reality and potential efficiency of a mining project and to avoid negative consequences that may arise from ill-considered planning.

Key aspects of pre-project monitoring include:

• Geological exploration and resource assessment. Detailed study of the geological structure and properties of the deposit allows for understanding the potential volumes and quality of minerals, their application area, as well as evaluating the technical aspects of extraction.
• Risk assessment and corresponding strategies. Identifying possible risks associated with geological, environmental, technical, economic, and legal aspects of the project is a key part of pre-project monitoring. Developing risk minimization strategies helps avoid potential negative consequences.
• Economic evaluation of the project. Assessing the project’s cost, investments required in both equipment and permitting documentation (EIA, design, reassessment, etc.), and potential profits based on realistic reserve estimates helps understand the commercial attractiveness of the project.
• Environmental analysis. It’s important to determine the feasibility of the project, considering environmental aspects. The presence of water bodies, nature reserves, the Emerald Network, water fund lands, coastal protective strips, the presence of infrastructure objects and their protective zones (power lines, water, gas and oil pipelines, wells, etc.), residential buildings, and others.

Conducting pre-project monitoring allows investors and exploration companies to make an objective assessment of a potential project and make informed decisions regarding its implementation. Taking into account the results of pre-project monitoring helps avoid the negative consequences of investing substantial funds into projects that may be unprofitable or impossible to implement. Often, these consequences are associated with a mismatch between expectations and reality, which can become an obstacle to the successful implementation of a mining project.

Thus, the appropriateness of conducting pre-project monitoring for an investor is beyond doubt and is a very important stage before making the decision to invest in a mining project.

It’s worth noting that specialists from the Geological Investment Group conduct pre-project monitoring of plots, deposits, and areas that are investment-attractive to the client. Pre-project territorial studies are important for subsoil users as they help understand the complexity of developing a mining project and minimize financial risks.