CUT-OFF GRADES IN MINERAL EXPLOITATION

Thumb Rules
Versus
Value Max imization Strategies

HO NO URI NG
KEN NET H F. LA NE

Parag J. Dutta
Ass is tant Profess or
Department of Geology
Cotton College, Guwahati
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Seminar: Cut-Off Grades

Contents

1 Introduction ........... 2
Long Term Strategies
Short Term Tactics

2 Overview of Kenneth Lanes Theory ....... 4

3 Maximum Present Value... 6

The Variables and the Value Surface
Optimum Exploitation Track: The Strategy

4 Operational Components .......... 10

Capacities and Constraints
Optimum Present Values: The Three Forms

5 Derivations for Cut-Off Grades ..... 12

Limiting Economic Cut-Off Grades
Balancing Cut-Off Grades
Effective Optimum Cut-Off Grades

6 Optimum Cut-Off Policy ................... 16

Calculation of the W sequence: The OGRE Program

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Seminar: Cut-Off Grades

Introduction
Every mine operates with a cutoff grade. Firstly, what is a cutoff grade? It is simply the number
which defines the boundary between Ore and Waste. Ore above cut off can be treated and
sold at a price equal to or above break even. Material below this cut off is waste. What
determines that value for a specific deposit?

Tradition and rules of thumb are not uncommon, and often the number is imposed on the
operation from some distant head office. These often are still true today. And where there has
been some science applied, it is still not uncommon to hear comments along the lines of The
correct cutoff grade is the operating cost breakeven. In other words, if a block of rock can cover
its own costs, it is ore and should be mined. But, this is unlikely to result in value maximization!

Long Term Strategy

If the key goal of a company is long term value maximization, then the cutoff grade must be
specified by determining what cutoff grade causes that goal to be achieved. Simply, we must
evaluate a range of cutoff grades (or more correctly cutoff grade policies over time), and
ascertain which of these gives the maximum value. Except for mature mines nearing
exhaustion, the cutoff grade which maximizes long-term value will almost certainly be higher
than the operating breakeven. A single relatively arbitrary cutoff grade may be close to optimal
for one strategy, but not for another. Selection of the first strategy will not be unprofitable, but
could have a significantly lower value than other at its optimum cutoff grade. (See Figure 1)

Short Term Tactics

Lane (1988) has presented a number of formulas and a process which can be used to identify
the optimum cutoff grade to use tactically in the short-term, while still operating strategically
within the context of a long-term cutoff policy. Very simply, in the short-term an operation may
be limited by its ability to generate rock (both ore and waste), produce and process ore, or make
and market product. If either of these is the case, the cutoff will be the grade which maximizes
the short-term value, taking account of the appropriate constraint. Alternatively, the appropriate
cutoff grade may be that which results in a physical balance between the capacities of two of

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Seminar: Cut-Off Grades

these components of the system. It is quite possible that a variation of the operating
breakeven may be the best cutoff grade in the short-term. But if this is allowed to drift on and
become the de facto long term policy, the value of the operation will quite possibly be
significantly reduced. It is worth noting that the short-term cutoff decision is totally constrained
by the existing capacities of the components of the operation and the state of the mine. The
removal of bottlenecks etc is part of the longer term plan, which also includes the long-term
cutoff policy. The long-term and short-term cutoffs are obviously related, but they are distinct
and must not be confused. Lane refers to them as planning and operational cutoffs.

Figure 1: The danger of a single cutoff. Strategy1 is selected using an arbitrary cutoff grade, but
Strategy2 would have been better, and the extra value foregone cannot be recovered.

The science of cutoff grades has come a long way, but theres still a long way to go in the
practical application of the theory in the industry. Those who persist in using an operating
breakeven as their cutoff in the long term may never make a loss, but theyll never maximize the
value of their operation either!

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Overview of Kenneth Lanes Theory

The fundamental concept of Kenneth Lanes Economic Definition of Ore depends on current
prices, costs and performance. The value of a mine is derived from the future project cash flows
summarized in present value of internal rate of return. But the valuation of a deposit is
complicated by the special considerations in valuation of exhaustible resources. The cash flow
model is based on three main components of a mining operation: mineralized material, the
development component; ore, the treatment component; and mineral, the marketing component.
Thus, there are mathematical formulae to determine the mine limiting cut off; the treatment
limiting cut off; and the market limiting cut off. The problem gets more complicated when several
components in the ore limit the throughput of the mining system. Then a balancing cut off
grade must be the objective. In the search for the optimum cut off grade Lane defines three
limiting economic cut off grades and three balancing cut off grades; then the problem is to select
one of these as the optimum.

The author introduces several complications into the fundamental formulae. There is first the
problem of the need for long-term forecasts of prices and costs, subject to differences of opinion
on how to best model future cash flows. Then long-term planning requires information on ore
grade distribution, often easy to find for the short term, but much more difficult if the view is five
to ten years in the future. Forecasts of this length are certain to be less reliable. While the
author considers the question of ore reserve estimation beyond the scope of the book, there is a
question of practical selectivity in mining and the accuracy of estimates of ore grade. Here, also,
the author makes the important point that cut off is an operational criterion at the point of mining,
not a criterion for deciding whether an area should be mined. The latter involves a separate
economic analysis.

The fundamental formulae lead to a cut off grade decision at a single point in time; yet long-term
planning requires a sequence of optimum cut off grades over an extended period. The planner
must develop an optimum exploitation track for the entire mineralized body. It is then that the
computer becomes essential to meet modeling objectives. There are more complications when

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Seminar: Cut-Off Grades

the cut off is parametric .ie. only indirectly related to the grade distribution. These include
situations where metallurgical-recovery, the presence of minor minerals and inaccuracies in
grade control, affect the cut off grade. There are also problems in finding a check for actual
versus predicted grades, easy conceptually but complicated by the ore and waste handling
process that is likely to mix material before and during mining and processing.

Optimum cut off policy generally indicates a decline in cut off grade over the life of the mine.
Grades uneconomic in the early years may be economic later. This introduces the possibility of
a stockpiling strategy with accompanying problems in logistics, additional cost and the
possibility that the stockpiled material may deteriorate over time. It also raises the question of
possible price changes that may make todays waste economic in the future.

The author introduces the questions of mine expansions and the development of new mines.
Expansion has the advantages that it may involve marginal expenditure, less risk, and a known
and stable market. On the other hand, a new mine is likely to offer the best opportunity of
controlling the economics of a specific mine: the main elements of exploitation strategy, method,
scale, and cut off policy are decided when a new mine is opened. When the deposit involves
more than one mineral there are accepted ways to model for a cut off grade decision. The
author briefly describes three other economic models. These introduce tax considerations,
variations of mill recovery and variations in system throughput.

The basis of derivation of the maximum present value with respect to the remaining resources,
corresponding to various constraints of the mining system is explained in the following pages.
The mathematical iteration technique for the calculation of an optimum cut off policy over the life
of a mine is also explained herein, in brief.

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3
Maximum Present Value
The NPV (Net Present Value) criterion is consistently quoted as the principal determinant of
economic value in mining operations and the relationship between cut-off grade and NPV
provides a means by which cut-off grades can be optimized. The present value for any mining
operation is the sum of all future cash flows discounted by an appropriate rate of interest, which
should at least be equal to the cost of capital. For the purposes of a discounted cash flow
analysis, Lane defined value as a function of: the instant of time (T) to which the cash-flows are
discounted (dependent on the prices and cost prevailing at the time), the amount of the
remaining ore resource (R) and the operating strategies to be employed in future (O) i.e.
V = V (T, R, O)

If V is allowed to vary for all conceivable values of O, it will have at least one value which
maximizes V (T, R, O). Thus, MaxO {V (T, R, O)} = V* (T, R)

The Variables and the Value Surface

The function V*(T, R) being a function of two variables, forms a surface termed as the maximum
present value surface (see Figure 2).

V* contours (Rs. in 000 Crores)

V* = 4
V* = 3

V* = 2

Resource V* = 1
Available
(R)

V* = 0

Time (T)
Figure 2

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The curved lines in the figure are V* contours. For R = 0, i.e. when the resource is totally
exhausted, V* = 0; hence the surface slopes to zero along the R = 0 axis, which is the zero
present value contour. A pattern of this kind arises from projections of prices and cost which
deteriorate in the initial years and then persistently improve. Projections of constant prices and
costs give rise to horizontal parallel values implying that the present values are not affected
unless some resource is consumed. Every exploitation strategy has an associated sequence of
present values defined by the rate of consumption of the resource, called the exploitation track.
It is to be noted that this surface corresponds to an optimum exploitation strategy; hence, only
the present values corresponding to an optimum exploitation track will lie on this surface. When
equality occurs, the remainder of the track from the point of equality onwards defines an
optimum strategy track. The present values at every subsequent point along such a track must
also equal to the corresponding maxima lying on this surface. In other words, optimum strategy
tracks are embedded in the maximum present value surface.

Optimum Exploitation Track: The Strategy

In order to find an optimum exploitation strategy and the corresponding maximum present value
in a particular case, only the surface in the immediate vicinity of the track matters. If some way
of deciding the direction of the track at any stage can be found then, given some starting point,
the track can be followed and its associated present values compiled.

Let a small decrement (r) in the resource occur at time T. Let the operating strategy for affecting
this decrement be an optimum strategy which is part of an optimum exploitation track. The time
taken to process one unit of resource is given by (t = t / r), wheret is the time taken to process
the small decrement of resource. If the
corresponding cash-flow generated be C
then, the cash-flow generated per unit of
resource is given by c = C / r.

Let d be the cost of capital and V be the

total capital value and W be the value of
the remaining resource.

By definition of present values, V = rc + V

/ (1 + d) t

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Since, the entire operation has been considered as part of an optimum exploitation strategy, we
can take the present value to be maximum, denoted by V*. Hence, the expression can be
written as:

V* = rc + V* / (1 + d) t

Lets focus on the second part of the equation, namely, V* / (1 + d) t

Using the Binomial theorem, (1+n) m ?(1+nm) if m << 1, and assuming both r and t to be small
and taking the first order approximation of the Taylor series expansion, assuming the
differentials are at the point R and T, produces the following:

(1 - dt) V* + tdV*/dT rdV*/dR

Rewriting the entire equation,

V* = rc + (1 - dt) V* + tdV*/dT rdV*/dR
or, rdV*/dR = rc + t (dV*/dT - dV*)
or, dV*/dR = c (t/r) (dV*/dT - dV*)

dV*/dR = c t (dV*/dT dV*) = c F t .. [1]

According to Lane, the optimum exploitation strategy for maximizing the present value of an
operation based on a finite resource can be determined by maximizing the above expression.
The opportunity cost (the term F) is derived from the premise that capital carries two penalties:
firstly, the interest that could be earned by investing the capital elsewhere (dV*), and secondly,
depreciation in value due to the operations (- dV*/dT).

The above equation shows that the change in value, that accompanies the depletion of the ore
reserves, is the cash flow associated with the mining of those reserves minus the opportunity
cost. It implies that the strategies must be chosen in such a way that every decrement in the
resource has the greatest possible effect on V*. On the maximum present value surface, the
optimum strategy is that one which follows the track of the steepest slope till the entire resource
is exhausted (R = 0). The other important point to be noted that in order to determine the
optimum exploitation strategy at any point, the only information that is required from the
remainder of the optimization process, in the future, is the value of F.

Lane defines the opportunity cost as the value of F which sets NPV to zero when the resource
is depleted by a complete optimum exploitation strategy. Indeed, this is the further premise of

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Lanes theory says that there exists an optimal exploitation strategy for the depletion of a finite
mineral resource, which is defined as a path of maximum NPV, by realizing that each
successive increment of depletion should maximize the NPV of the remaining resource. In terms
of defining this optimal strategy, at each decrement of depletion, a re-examination of the existing
constraints, the opportunity cost and the associated cut off grade be made, so that an optimal
cut off grade policy be defined over the life of the mine.

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4
Operational Components
There are three main components of a mining operation namely, mining i.e. extraction of ore
from mineralized ground, processing i.e. metallurgical treatment and marketing i.e. supply
corresponding to forces of effective demand. Each one of these 3 operations is related to its
corresponding respective throughput:

Mining mineralized material (ore and waste),

Processing ore (proportion above cut-off)

Marketing metal

Capacities and Constraints

Each component has its own capacities and costs which are shown with symbols in the
following table: Mining capacity M, is a function of mine design, access, labor, infrastructure,
and available face length, whereas Treating capacity H, is a function of the number of crushers,
ball mills, absorption tanks etc. in the mill. Marketing capacity K, may be constrained through
selling constraints or long-term contracts, but is also related to the smelting and refining
capacity of the refinery. All capacities can be expressed in Mt/a.

Component Material Quantity Variable Cost Capacity (Mt/a)

Mining Ore and waste 1.0 m M
Treating Ore Proportion above cutoff (x) h H
Marketing Metal xy g k K

Using the above notation the cash flow arising from one unit of mineralized material can be
expressed as:
c = (p k) x y g x h m f t [2]
where, t = time taken to work through one unit of mineralized material
y = yield of mineral in the treatment process (100 y %)
f = time costs per year (fixed costs)
c = cash flow per unit of mineralized material
g = average grade of the ore (mineral: ore ratio)

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Output in mining operations may be limited by capacity in one of the three stages: mining,
treating or marketing. The time taken to process one unit of mineralized material t , in the
above equation is governed by the limiting capacity of the three stages of the mining operation.
Thus, it is determined by the component: mine, treatment, or market which is limiting the
operation.

t=1/M for mine limiting

t=x/H for treatment limiting
t = xyg / K for market limiting

When the mine has a bottleneck and limits the operation, the opportunity cost is incurred per ton
of material mined, since the mine is responsible for delaying the future cash flows. However, the
mill and refinery are underutilized, so, ore can be processed and concentrate is refined as soon
as material is mined. Similarly, when the treatment plant has a bottleneck and hence delays the
operation, the opportunity cost is distributed per ton of ore processed. Again, if the market or
refinery is subject to delaying the future cash flows, the opportunity cost is distributed per unit of
concentrate refined.

Optimum Present Value The Three Forms

Combining equation [1] and [2], the expression for determining optimum cutoff grades becomes :

dV*/dR = (p k) x y g x h m (f + F)t
v = (p k) x y g x h m (f + F) t . [3]
where, dV*/dR = v

Substituting the values of t in equation [3] for each case of the dominant capacity constraint,
three corresponding expressions for the optimum present value are generated:

v m = (p k) x y g x h m (f + F) / M for mine limiting

v h = (p k) x y g x h m (f + F) x / H for treatment limiting
vk = (p k) x y g x h m (f + F) x y g /K for market limiting

Graphs of these three representations of present value as a function of the cut-off grade are all
convex upwards with a single maximum that is the limiting cut-off grade for the limiting
component concerned (refer figure 3).

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5
Derivations for Cut-Off Grades
In the three expressions of maximum present value presented above, the proportion of
mineralized material above cut-off (x), and the average grade of the ore above cutoff ( g ), are

directly dependent on the cut-off grade and are the only terms which vary with the cut-off grade.
Hence, the optimum cut-off grade can be derived, for each of the three cases, by considering
these terms, at the breakeven point. Accordingly, the three optimum cut-off grades (gm, gh , gk )
called the limiting economic cut-off grades, corresponding to each of the three cases, can be
expressed as:

Limiting Economic Cut-Off Grades

gm = h /(p k) y for mine limiting

gh = {h + (f + F) / H} / (p k) y for treatment limiting
gk = h /{p k (f + F) / K} y for market limiting

Considering the above expressions, the following points are worth noting:

1. For mine limiting operations the value of mineralized material need only cover the
variable cost of treatment (after allowing for marketing cost). This is the clearest
definition of marginal ore that is available. Neither time cost, nor mining/development
costs are relevant.

2. There is no reference to present value hence a mine that is limited by mining capacity
should be operated on a tactical rather than a strategic basis. This means no matter
what the current cut-off grade policy is, there is no way to make gains now that can act
as a trade off against losses in the future. Where a decision has been made to continue
operating, there is no limit to treatment capacityincrease output as price rises.

3. For the treatment limiting case we see that the opportunity cost F = dV*/dT dV*
appears simply as an additional time cost factor, and this makes the cut-off
determination significantly different from conventional methods.

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4. For the treatment and marketing cases, the cut-off grade declines as the opportunity
cost declines because the remaining life of the mine is reduced.

5. None of the formula makes direc t reference to the grades present in the mineralized
rock. The cut-off is calculated with reference to costs, prices and capacities regardless of
the way the grades actually vary within the mineralized body.

6. A close look at the equations of limiting economic cut-off grades reveals that in any
mining situation, the optimum cut-off grade will never be less than gm , since it is the
breakeven cut-off grade. Also, the optimum cut-off grade will never be higher than gh,
since, this means rejecting valuable ore as waste. Hence, gm = gk = gh

7. The most important fact to be noted is that the above formulae apply to actual grades as
they occur in the ground and are note necessarily identical with the grades as measured
for the implementation of a cut-off grade decision. There may be discrepancies between
the theoretical boundary separating ore from waste as calculated by the above formulae
and the actual separation achieved in practice. In these cases, the operational cut-off
grade is called a parametric cut-off grade because it indirectly related to the real grade.

Balancing Cut-Off Grades

The throughput of the mining system may be limited by capacity in pairs: mine-treatment plant,
mine-market or market-treatment plant. In these cases, the concept of balancing cut off grades,
is applicable where constraints are in balance, and the mining , processing and marketing
systems work in balance, such that capacity is fully utilized, and that grade is optimized within
residual constraints.

An expression for cut-off grade in the ratio of the existing mining capacity M, and existing
treatment capacity H, would keep both these capacities balanced and both components would
simultaneously be at full utilization. This is the mine/treatment plant balancing cut-off grade, gmh.
In a similar manner, the mine/market balancing cut-off grade gmk and the treatment plant/market
balancing cut-off grade ghk can be formulated.

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Effective Optimum Cut-Off Grades

We have already noted previously that gm = gk = gh. Thus, an effective optimum cut-off grade
that maximizes the present value is between gm and gh. Accordingly, the three balancing cut-off
grades, gmh, gmk , and ghk also lie between the extreme two values. Therefore, the problem of
determining the optimum cut-off grade policy is in fact the determination of optimum cut-off
grade among the three limiting economic and three balancing cut-off grades that maximizes the
NPV of operation. This argument helps in defining the selection criteria of the effective optimum
cut-off grade as follows:

If Gmh is the optimum cut-off grade satisfying mine and treatment capacity constraints, then:
Gmh = gm if gmh = gm
Gmh = gh if gmh = gh
Gmh = gmh otherwise

If Gmk is the optimum cut-off grade satisfying mine and market capacity constraints, then:
Gmk = gm if gmk = gm
Gmk = gk if gmk = gk
Gmk = gmk otherwise

If Ghk is the optimum cut-off grade satisfying treatment and market capacity constraints, then:
Ghk = gk if ghk = gk
Ghk = gh if ghk = gh
Ghk = ghk otherwise

The overall effective optimum cut-off grade is now one of the three: Gmh , Gmk , and Ghk . The
largest present value achieved at any cut-off grade, allowing for capacity constraints, is limited
by the least of vm , vk and vh. The effective optimum cut-off grade obviously corresponds to the
highest point within these limits. This effective optimum cut-off grade always occurs at the
middle value of Gmh, Gmk , and Ghk . The position has been illustrated graphically in Figure 3. The
above-mentioned selection criteria reveal that the middle value of Gmh, Gmk , or Ghk need not
necessarily be at the intersection points of the maximum value curves, gmh, gmk , ghk but can be
at one of the maximum points at gm , gk , or gh. In the latter case, the total capacity is limited by
the one stage only and two of the associated values of Gmh, Gmk , or Ghk coincide.

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Figure 3 Effective optimum cut-off grades for the mining, processing and marketing stages of a
mining operation. The thick line at 2.84 g/t defines the optimum operational cut-off grade

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Optimum Cut-Off Policy

Calculation of a sequence of optimum cut-off grades over an extended period constitutes an
optimum cut-off policy. An optimum cut-off policy corresponds to a complete optimum
exploitation strategy for the resource under consideration. The problem is to find an exploitation
track along which a consistent associated sequence of present values with a given terminal
value is achieved. This then an optimum exploitation track and the present values at every
stage along it are maxima. If the period of which a policy is to be determined is the remaining
life of the operation, the terminal present value is zero.

Complete cut-off policies are not a normal requirement for day-to-day operations of mine, but
they are important for longer range mine planning. Future cut-off grades affect development
requirements, equipment utilization and output. They also affect the future cash-flow the
resource which underlies all planning.

The main problem in calculating a cut-off policy as opposed to a single optimum cut-off grade is
from where to start because the initial levels of present value are unknown. Lane (1988) had
developed a mathematical iteration process to overcome this problem. In this iteration process,
initial levels are assumed, a policy calculated, and the present values on termination compared
with the specified terminal value. Depending upon the difference, the initial levels are modified
and a new policy calculated.

A major complication arises while determining dV*/dT, the rate of change of present value with
time. An estimate of this term is the difference between the present values at the beginning and
end of a certain time period for the same quantity of the resource remaining. As a consequence,
two initial levels have to be assumed and followed in two parallel streams. Supposing Vi be the
present value at the beginning of year i and W i be the present value at the end of year i, with the
same resource remaining, then,

(dV/dT)i = W i - Vi

and Fi = dVi - (dV/dT)i = dVi + Vi - W i

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Using this value of Fi, the economic parameters for the period i and the mineralized reserve
grades for the appropriate increment, the effective optimum cut-off grade gi can be determined
and the corresponding cash flow Ci calculated from the formula

Ci = {(pi k i) x i y i g i x i hi m i} ri fi
where ri = resource consumed

Then the next present value in the sequence can be calculated as follows

Vi + 1 = Vi + d Vi - Ci
where d = interest at cost of capital

Calculation of the W Sequence (Present Value at the End of the Year)

The calculation of the W sequence is similar, but based on the economic parameters of the
following year. Estimation of the value of Fi + 1 (the prime refer to the W sequence) is as follows

Fi + 1 = dW i + Vi + 1 - W i + 1

A value for Vi - W i has to be taken as a first estimate for Vi + 1 - W i + 1 in the preceding formula
and another iteration has to be performed to converge on the value of W i + 1 through the
following:

W i + 1 = W i + d W i Ci + 1

A correction must, however be applied to W i + 1 for keeping the V and W sequence parallel, i.e.
W i + 1 must correspond to the same amount of resource remaining as Vi + 1. The rate of resource
consumption for the W sequence has to be the same as that of the V sequence in the preceding
year. Thus, the correction is: (Vi + 1 W i ) (ri + 1 ri +1) / (ri + 1 ri)

The modified formula for W i + 1 becomes

W i + 1 = W i + d W i Ci + 1 + (Vi + 1 W i ) (ri + 1 ri +1) / (ri + 1 ri)

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The end of a policy calculation is reached when the terminal value is zero or remains as
specified. At this point, both the V and W sequence should be close to the specified terminal
value. If not, the initial levels, V1 and W 1 must be modified and the whole process of iteration
repeated till the terminal value reaches the specified value.

Lane (1988) has incorporated the above iteration into the OGRE (Optimum Grades for
Resource Exploitation) program and is available from RTZ Consultants, U.K., on request.

******************************

Referred to:
Lane, Kenneth F., 1988. The Economic Definition of Ore: Cut-Off Grades in Theory and Practice.
Mining Journal Books Ltd, London, 149 pp.

Mr. Kenneth F. Lane

RTZ Consultants Ltd.
Castle Mead, Lower Castle Street,
Bristol BS99 77R
U.K.

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