The Reserve Life Cover Ratio (“RLCR”) is used only for mining and oil & gas projects (inclusive of fossil fuel generators tied to a particular mine/gas development).
Unlike the other covenants we’ve looked at, the RLCR does not look at any cash flows or balances. This makes it easy to calculate and means you don’t need to try and forecast commodity prices (although you’ll be doing that elsewhere in your financial model anyway).
The calculation is simply total recoverable reserves divided by the total amount of the commodity shipped during the loan term. This of course hides some complications.
Basis of measurement
As with other covenants, you need to ensure that you are measuring the denominator and numerator on the same basis. For LLCR and PLCR calculations this usually means making sure your time periods match up. For an RLCR, it means that your reserves and production are calculated the same way. Reserves are calculated based on the amount of the mineral that can be recovered economically at a particular reference point, usually at delivery to the processing plant (see clause 29 of the JORC code for more detail). It therefore does take into account expected mining methods and costs, but the final amount of tonnes reported as reserves do not necessarily allow for the portion of the mineral that is lost during processing. Reserves will also include diluting material delivered for processing, or are dispatched from the mine without treatment (JORC Code 2012 clause 29).
For example, you might have a copper mine that has reserves of 1.5MT. During the 5 year term of the loan, the project expects to sell 1.0MT of metal, giving an RLCR of 1.50. However, the processing plant only has an efficiency of 66.67%, meaning that one-third of the metal contained in the mined ore is lost to waste. This means that the “true” RLCR is really only 1.00, not a good situation. Your RLCR needs to take into account production losses (over and above any dilution assumed in the reserves calculation and mine plan) for it to be worth anything.
Reserves are resources that are economically viable to extract, taking into account a number of modifying factors. In determining this viability, the estimate must take into account the expected prices for the final product. If the price used in the reserves estimate is significantly different to the price you are assuming in your financial model assessment, then there is a risk that amounts currently classified as reserves would not actually be extracted,
For example, a gold mine might have 2 million ounces of Proved reserves based on an expected price of $1200/oz. If a price of $900 had been used there might only be 1.5 million ounces of Proved reserves. Which is “correct” depends on current and future gold prices, and needs to be taken into account when calculating an RLCR in your financial model.