The Importance of Contracting for Accurate Sampling Mechanisms And Procedures in Mineral Ore Supply Contracts

With the price of metals, such as gold, at historic highs, it is important that producers and processors of minerals bearing valuable metals understand the importance of contracting for accurate sampling measures in their relationships. Most supply contracts are written to determine payment based on the spot price of the metal as of a certain date. Typically, a supply contract will contain a calculation of the metal content of the shipment multiplied by the spot price, less certain processing costs. The determination of the quantity of the metal contained in the mineral or ore is therefore crucial to both the supplier, who expects to be paid the fair value of its product based on the value of the metal contained in the raw material it ships, and the processor, who seeks recover the full value of the metal from the raw material. Inaccuracies in sampling and measuring potentially cost either party to this transaction enormously, as even the slightest mistake in determining the true metal content of a shipment can cost millions of dollars in overpayment to the shipper or underpayment to the supplier, depending on the nature of the mistake.

Inaccuracies in sampling procedure are heightened when the supplier and processor are engaged in an arms-length relationship; that is, where the mineral is mined and supplied by parties not related to the processor. Many large mining concerns mine and then process their own materials through milling, smelting or other techniques. In these cases, the mining and mineral extraction divisions of the concern essentially have the same identity and goals. At the same time, many mining and processing companies also purchase raw materials (ore) from third party mines or suppliers to supplement their own supply and production. Given the amount of money at stake in the supplier/processor relationship, one would imagine that the supply contracts would contain clear and specific terms regarding how the parties shall measure the amount of metal in the shipment. However, many such contracts lack these essential terms, leading to problems and potentially disruptive and costly litigation.

Illustration

Company A is a large mining concern that operates a mill on premises. In addition to milling its own ore, it purchases ore from third parties, commonly referred to as “toll ore”, to supplement its metal production. Company B is a toll ore provider, with the capacity to mine but without the means to economically process the valuable metal itself. A and B contract for A to supply its ore to B for processing at A’s mill. A and B agree that B will be paid based on the metal content of its shipment determined by assays taken from samples of the shipment. Based on the metal content determined by the assay, the final payment for the shipment will be determined by multiplying the metal content determined by assays and the quantity of the shipment, times the spot price of the metal.

Based on this arrangement, there are numerous issues that should be addressed either prior to contract and within in the contract that may greatly affect the parties’ respective bottom lines. These issues include:

Do the Parties Understand and Agree How the Metal is Concentrated and Disseminated Within the Ore? An understanding of the texture and dissemination of the valuable metals, for example, gold, within the ore is critical to establishing an accurate sampling regimen. Texture refers to size, dissemination, association, and shape of the minerals within the ore. The metal may be finely disseminated within the ore, contained within a matrix of minerals, or clustered in crystals or nuggets. While this consideration may at first appear outside the scope of the legal considerations relative to a production contract, it may nevertheless be critical to a contractual relationship that depends upon an accurate assessment of the value of the ore in order to establish payment.

How will the Sampling Be Conducted? Do the Parties Agree that the Sampling Will Produce Representative Samples of the Entire Shipment?

Sampling regimen and methodology should be a primary concern to the parties and prior to contract. Among the considerations to be memorialized should be: which party is responsible for weighing and sampling; what is the quantity of ore to be sampled relative to the entire shipment; what technology will be used to conduct sampling, and whether the processor will permit the shipper to have a representative present to observe sampling. Ideally, the processor will have invested in a sampling plant utilizing the best available technology, including splitters, grinders, and separators that is entirely automated and calibrated to collect frequent representative samples of the shipment. If the sampling is not conducted properly, either party can suffer due to such occurrences as the “Nugget Effect”, where any given sample could randomly catch a cluster of mineral that skews the value of the sample artificially high to the advantage of the producer, or alternatively, misses valuable minerals that skews the value of the shipment artificially low to the advantage of the processor.

The ideal is for every mineral within the shipment to have an equal opportunity to be caught in a sample, and if the contract is not sufficiently negotiated and drafted to achieve this result, serious problems may occur. This is much easier said than done, and often the parties, due to lack of understanding or access to the best available technology, may unwittingly be obtaining samples that are too small relative to the shipment, inaccurately obtained due to the texture of the mineral contained in the ore, or otherwise not representative of the true mineral value of the shipment.

Counsel to parties entering to such mineral production relationships should discuss with their clients the feasibility of retaining sampling and processing consultants if there are any questions about whether the client is fully protected. The authors, for example, have worked closely with Francis Pitard Sampling Consultants which specializes in mineral sampling and processing methodology.

How Will the Samples Be Assayed? Is the Assayer Using Best Available Technology?
Historically, the assay is considered to be the most important test to determine the mineral content in a sample, since it produces a quantifiable reading of the actual mineral content. However, the reliability of an assay is only as good as the sample it’s taken from. Even the best assay techniques producing the most repeatable assay results can produce flawed results if the sample itself has not been accurately taken and thus does not reflect what is truly representative of the shipment.

Nevertheless, it is important to describe in the contract exactly how the samples will be assayed, where they will be assayed, and how the parties will compare assay results. Further, it is common and advisable to draft a procedure for conducting “umpire” assays if the differences between the parties’ respective assays are too great. The parties must also consider a method for custody and control of umpire assays and distribution of assay splits, how long assay samples will be kept, and the range of “splitting limits” that will determine whether the parties may go to umpire.

Deal With These Issues Up Front

Experience tells us that it is best to resolve these issues prior to contract. A mistake or misunderstanding in sampling can be extremely costly, and litigation over payments can be extremely complex and time consuming. It is better to make sure that the sampling practices are accepted and sound prior to the first shipment being made. However, even in situations where shipments have already commenced and payments have been made, the parties should not hesitate to seek legal counsel if there are concerns in these areas.