Inflation's bite into mine operating costs and capital planning deepened in the first quarter.

Soaring metal prices have kept profits up for metal producers, but their operating costs are rising far faster than anticipated. Increasing expenses for equipment will make new projects and mine expansions more costly. Gold companies are reassessing what rising costs and gold prices may mean for their ore reserve assessments, executives said on first-quarter earnings calls.

"Inflation is a very real concern," Cormark Securities analyst Stefan Ioannou said in an interview. "The first quarter was buffered by high metal prices, and the second quarter is off to a great start. But metal prices are starting to show a little bit of fragility. They're still good relative to historic numbers. But, nevertheless, inflation is a lot higher than it was ... so the margin squeeze is coming on."

Donald Lindsay, president and CEO of Canadian diversified miner Teck Resources Ltd., pointed to a 13% year-over-year jump in first-quarter operating costs on an April 27 call. South Africa-based AngloGold Ashanti Ltd.'s CFO Christine Ramon said May 9 that inflation helped drive up gold production cash costs by 8%, or $82 per ounce.

Miners also warned of higher than expected cost pressures in 2022. Barrick Gold Corp. President and CEO Mark Bristow said May 4 that unit cost guidance may hit the upper end of the company's range due to energy prices and supply chain issues, among other expenses.

Kinross Gold Corp. CFO Andrea Freeborough said on a May 11 call that in some cases inflation exceeded company expectations, which it set at 7% for operating costs and 10%-15% for capital expenditure. And Newmont Corp. President and CEO Tom Palmer said April 22 that cost pressures might raise the miner's unit costs by 3%-5% and push costs to the high end of its guidance.

Capex crunch

Inflation will hit hardest on capital expenditures for new developments, according to industry analysts and players.

"If I had to take a wild guess, I'd say 20% to 30% inflation on capital costs isn't crazy," John Burzynski told S&P Global Commodity Insights. Burzynski is the founder, executive chairman and CEO of Osisko Mining Inc. and a Canadian mining veteran who is leading development of the Windfall Lake gold project in Quebec.

Likewise, Ioannou said capex inflation is trending at about 25% for new mine developments and pushing projects back to the drawing board for revisions.

"Anyone that's got a big development project in the near- to medium-term pipeline is coming under scrutiny," Ioannou said. "The capex numbers are probably going to need to be revisited."

In the same vein, AngloGold CEO Alberto Calderon flagged "higher levels of cost pressures" on projects and pegged capex inflation at 8%-10%. "It is an issue," Calderon said on the company's May 9 call.

But rising capex does not yet appear to be delaying development plans, though inflation may check profit expectations for some. Most projects still have healthy margins, even if they cost 25% more to build, largely thanks to strong metal prices.

"It's just not quite as robust as it was six months ago," Ioannou said.

Further, supply chain snarls that are driving up prices for mining equipment and materials could prove fleeting, while pre-orders of equipment, made before inflation took off, could help blunt the capex pain for some, Burzynski said.

"It's sticker shock right now, and everybody's concerned about it," Burzynski said. "But I suspect that as quickly as they've gone up, the prices will roll back down."

Targeting reserves

Inflation is also driving some gold miners to revisit their ore reserve and metal price assumptions. Miners model reserves, the amount of ore that can be profitably extracted from a mineral deposit, using many different parameters such as diesel and gold prices that can become outdated due to high inflation and strong metal pricing.

Palmer said Newmont is "actively debating" the issue "as we think about whether we're getting into a zone where it's time to look at resetting the floor for [the] gold price."

Likewise, Kinross President and CEO Paul Rollinson signaled that the company may reconsider its reserve price.

"Our strategy is not around, I would say, the sins of the past, where people drop cut-off grades to try to paint a growth story," Rollinson said on the May 11 call. "Our thinking is really about, and I use the word carefully, maintaining our reserves by looking at higher gold prices to take into account that cost-of-inflation effect."

In the past five years or so, major gold miners have been wary of boosting gold price assumptions that define ore reserves even as the gold price climbed. Major gold miners have used price assumptions in the range of $1,200/oz to $1,300/oz for reserve estimates for years, though gold has largely traded over $1,800/oz since mid-2020.

"It's a balancing act. Historically, the industry used a lagging three- to five-year gold price history to set reserve pricing assumptions," David Harquail, chair of precious-metals royalty and streaming giant Franco-Nevada Corp., said in an email. "Then came the investor push about seven years ago for higher returns, which froze most operator reserve price assumptions at $1,200-$1,300/oz. The gap between annual gold prices and reserve price assumptions has never been larger."

Few development projects work at gold prices as low as $1,200/oz to $1,300/oz and most analysts have started using consensus outlooks around $1,600/oz for new builds, the company chair said.

"Investors are also becoming more accepting of the need to reinvest in the business," Harquail said.

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