By Brian Greene and Valentina Castillo

Renewable energy developers are set to strike gold in the next decade with inside-the-fence facilities at mines.

Mine owners are expected to invest $20 billion in new renewable energy facilities by 2020. Financial and energy security concerns are behind the investments. For project developers, this is good news. However, there are unique challenges when doing a project adjacent to a mine.

Mining operations, especially those that are located in remote off-grid locations or in developing countries with poor infrastructure, tend to rely heavily on diesel-fired generators for electricity.

Diesel oil prices have nearly doubled in the last decade. To make matters worse, mines today often extract lower-grade ores that take more power to reach. Thus, mines are using increasing amounts of energy to produce the same amount of output, which weakens the bottom line. Mines today spend 30% of operating costs on energy compared to 23% to 25% a few years ago.

The rigors of moving diesel to remote areas and grid instability in developing nations add to the challenges of running a profitable mining operation. Mines operate 24 hours a day, seven days a week, and they require a constant fuel supply. Extreme weather, poor infrastructure and frequent strikes delay diesel shipments. Grids in parts of Latin America, Africa and Asia are subject to frequent blackouts. To avoid shut-downs, mine owners spend large sums of money on transportation security and back-up generation.

These cost and security issues make mine owners ready to listen to proposals from independent power producers to supply electricity. Renewable energy is not expected to replace diesel as the primary energy source for mines, but there is ample room for it to be used in combination with diesel and other conventional energy sources as a means to reduce costs and mitigate transportation risk.

The intermittent nature of renewable energy and the present lack of economical energy storage options limit the extent to which mines can rely currently on wind and solar for their power needs. However, the potential cost savings are too great to ignore. Electricity from diesel generators costs 28¢ to 32¢ a kWh currently. Solar costs around 17¢ a kWh. The figure for wind is 14¢ a kWh.

One example of a successful hybrid solution is at the Thaba chrome ore mine in the Limpopo province of South Africa, where Cronimet Mining Power Solutions operates a 1-megawatt photovoltaic-diesel hybrid electric plant that currently supplies 60% of the energy requirements of the mine by combining solar panels with a diesel generator. The solar plant generates electricity during the day, and the generator supplies energy at night. By using solar energy, the mine is able to save on 450,000 liters of diesel fuel a year.

Challenges

There are several unique technological and financial considerations when trying to do a project near a mine.

The main financial challenge is finding a structure that allows financial participation by the mining company. Such companies prefer off-balance sheet financing that preserves their debt-to-equity ratios. The primary financial obstacle in structuring a renewable energy project with a mining company is managing returns based on the projected life of the mine, which can take 10 years to develop and then operate anywhere from 10 to 50 years, compared to a 20- to 25-year expected life for a solar or wind project.

Another obstacle is that mine owners are accustomed to modeling energy costs as ongoing diesel fuel costs rather than upfront construction costs for a power plant. One way to bridge this is for the independent power company to retain the power plant and sell electricity to the extent local law allows.

Choosing an energy source to supplement diesel requires balancing financial considerations such as what energy will best deliver the lowest-cost energy and closest to a fixed price, how long it will take to develop the project and the variability of the electricity output. All these factors affect how soon a mining company can reap the financial benefits of a renewable energy project and how consistently those benefits will be produced. There are important tradeoffs. While a solar plant can be developed in 18 months and its price can be predicted with a great degree of certainty, its energy production is highly variable. A wind project can take 36 months to develop. Furthermore, it can be difficult to predict its costs and it, too, generates a variable amount of energy. In contrast, while a geothermal plant might produce a constant amount of energy, it requires 48 to 60 months to develop, how much capacity the geothermal field can support is hard to predict, and there are higher operating costs.

Mines are usually in remote areas like far northern Canada, the African desert or tropical forests or mountains in South America. These areas are subject to extreme weather conditions such as dust, humidity, heat, snow and little to no access to water. Equipment must be designed to deal with these challenges. For example, wind blades in cold weather need de-icing and solar panels in very dry areas must be able to produce energy despite extreme dust. Repair and upkeep are difficult in remote sites and can drive up costs.

Several Project Structures

Three main ownership structures have been used for projects at mines.

Each structure requires a creditworthy offtaker or hedge counterparty (in cases where a contract for differences or synthetic power purchase agreement is used) in order to tap financing from banks or multi-lateral lending agencies.

In one structure, the mining company is the offtaker. The mining operator merely contracts to buy energy from (or enters into a hedge with) a renewable energy project, and thus avoids putting any of its capital at risk. An example of such a project is the Pampa Elvira thermosolar plant in Chile developed by Energía Llaima and Sunmark. The $26 million plant supplies electricity to Codelco’s Energía Llaima copper mine in the Atacama desert under a fixed-price and fixed-quantity power purchase agreement. Codelco expects to save the equivalent of two months of diesel oil each year under the arrangement.

The 100-megawatt CAP Amanecer project developed by SunEdison, also in the Atacama desert in Chile, is a variation on the same theme in that the project will sell its energy into the spot market with the project company entering into a 20-year contract for differences with a subsidiary of the Chilean mining company Compañia de Acero del Pacifico S.A or “CAP,” effectively allowing the project company to receive a fixed price for the energy it produces. CAP has the downside risk if energy prices drop below the contract price, but receives any revenue from selling energy for more than the contract price.

The contract-for-differences model may be of particular interest to large mining companies that have more than one mine connected to the grid in a particular area and that are looking to hedge their exposure to fluctuating energy prices.

Another structure is to make the mining company a co-investor model. It enters into a partnership, joint venture or other co-investment structure with the developer. Under this structure, the mining company benefits from the developer’s experience and the two parties share the financial risk. Depending on the structure, the mining company may be able to depreciate its investment for tax purposes. A co-investment could be structured as a lease or sale-leaseback.

An example of such a structure is a project undertaken by Xstrata Copper and Origin Energy Limited in Chile. Origin purchased a 51% stake in Energía Austral, which owns the development rights to three proposed hydroelectric plants with an expected capacity of approximately 1000 megawatts, from Xstrata Copper in 2012. The copper company retains the other 49% interest. Origin brings both a known hydroelectric track record and a substantial amount of capital. Origin is investing $75 million initially to complete a project feasibility study. Should the project pass the feasibility study, Origin will invest another $75 million.

The co-investment by Brazilian mining giant Vale SA and Australian renewable developer Pacific Hydro in two wind projects in the state of Rio Grande do Norte is another example of the partnership model and follows a more basic structure. Vale and Pacific Hydro will each own 50% of the projects, which are expected to be constructed in 2014 and will have a combined capacity of 140 megawatts and produce renewable energy for at least 20 years.

A third common structure is for the mining company to take the lead role in developing a renewable energy project. The independent power company act as the EPC contractor, operator or equipment supplier. Variations on this structure might be a build-own-transfer or build-own-operator-transfer model that has been used in the past for large power projects in emerging markets.

The mining company may already have many of the engineering, design and construction skills required successfully to complete a project. For example, Rio Tinto, a mining company, used its own resources to build a wind farm with four 2.3-megawatt wind turbines to support its Diavik diamond mine in the Northwest Territories in Canada. Most of the wind turbine installation was designed in-house, and the company used its own communications protocol and design rather than the turbine supplier’s SCADA communications system. It also relied on its own crews and mining equipment to build roads, blast foundations, mix and pour concrete and tie into overhead power lines.

The key drawback to such a structure from the perspective of the mining company is the high upfront capital cost.

Many more power projects at mines are on the drawing board. Other structures may emerge.