Tuesday, March 21, 2017

Oh Fortuna

Yesterday Fortuna Silver made an astonishing annoucement. Let me cite the most interesting part:

"As part of a review by the staff of the United States Securities and Exchange Commission (the "SEC") of the Company's Annual Report on Form 40-F for the year ended December 31, 2015, the SEC has provided comments on the Company's use of inferred resources in its audited financial statements for the calculation of depletion expenses (the "SEC Comments"). The Company considers the use of its inferred resources in the calculation of depletion expenses to be appropriate under IFRS and consistent with the practice of other Canadian mining companies. However, until the SEC Comments are resolved, the Annual Financial Documents cannot be finalized"

It looks like the company was calculating its depletion cost using inferred resources. Interestingly, Fortuna claims that everything is alright but is it?

Here is an excerpt from the company's 2015 Annual Report, page 11:
"Costs of producing properties are amortized on a unit-of-production basis over proven and probable reserves and the portion of resources expected to be extracted economically"
Maybe I am blind but there is nothing about inferred resources. To remind my readers - according to the Canadian Institute of Mining (CIM):
"An Inferred Mineral Resource is that part of a Mineral Resource for which quantity and grade or quality are estimated on the basis of limited geological evidence and sampling. Geological evidence is sufficient to imply but not verify geological and grade or quality continuity.
An Inferred Mineral Resource has a lower level of confidence than that applying to an Indicated Mineral Resource and must not be converted to a Mineral Reserve. It is reasonably expected that the majority of Inferred Mineral Resources could be upgraded to Indicated Mineral Resources with continued exploration"

In other words, inferred resources are that part of a mineral resource which cannot be converted into reserves, is not economically viable and is not "the portion of resources expected to be extracted economically".
Simply put, inferred resources are just a dream that may become reality in the future (rather distant future). What is more, converting inferred resources into reality definitely takes time and a lot of money but the final result may be a complete fiasco.
Summarizing - in my opinion, inferred resources cannot be taken into account when calculating depletion.
The problem is that mining companies do not disclose how they calculate depreciation of their mineral properties (where depletion accounts for the biggest part of this cost). Who knows, maybe Fortuna is not just an exception - the company states that its practises are: "consistent with the practice of other Canadian mining companies". By the way, I would like to know which companies calculate their depletion in the same way as Fortuna does... 
Now the question is what if the SEC is right? Well, higher depletion means lower taxes (higher expenses = lower taxes). What is more, if the company has been calculating its depletion incorrectly for many years it would have to pay the taxes due plus some fines. Next, it would have to recalculate its past financial statements. Many problems ahead.
I hope Fortuna is able to explain everything and focus on its business (any dispute with the taxman is time, energy and money consuming)....

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