Fresnillo Plc (OTCPK:FNLPF) Q4 2021 Earnings Conference Call March 8, 2022 4:00 AM ET
Company Participants
Gabi Mayor – Head, Investor Relations
Octavio Alvídrez – Chief Executive Officer
Mario Arreguín – Chief Financial Officer
Tomas Iturriaga – Chief Operating Officer
Guillermo Gastelum – Vice President, Exploration
Conference Call Participants
Jason Fairclough – Bank of America Merrill Lynch
Krishan Agarwal – Citi
Amos Fletcher – Barclays
Tyler Broda – RBC
Gabi Mayor
Thank you. Good morning, everybody. Thank you for coming to Fresnillo’s Preliminary Announcement for 2021. I’m glad to present you our senior management team. After two strong years of COVID, we have Octavio Alvídrez, our CEO; our CFO, Mario Arreguín; our COO, Tomas Iturriaga; our VP of Exploration, Guillermo Gastelum, and we are very glad to have them back in London.
And with that, I will hand it over to Mr. Alvídrez. Thank you.
Octavio Alvídrez
Thank you, Gabi. Thank you, everyone for being here for year-end announcement. I’m glad to be here with our CFO, Mario Arreguín, our COO, Tomas Iturriaga, and our Vice President for Exploration. Glad to be in person, again, although deal with some limitation by COVID and I think we have a limit number on this meeting room.
As always, I would like to go to the disclaimer first and to point out then after the agenda. I will run you through some of the key highlights financial and operational and then Tomas Iturriaga will follow-up with our operation performance and development projects, followed by Guillermo Gastelum, who will talk to us about reserve resources and the exploration pipeline. And then after Mario Arreguín will discuss the financial details before I come back and do some final comments and also the outlook.
But our main focus this morning will be to provide you with more details as we go on a more normalized performance after being hit on the second half of last year, by some of the external factors in Mexico out of our control.
Some of those from the COVID side as we thought we had gone through those. Also some of the new regulatory framework in Mexico and how we are addressing those issues and how we are trying to get to a more normalized performance.
If we go to following page, please? You will be familiar with our investment proposition. It remains compelling. High-quality assets 2.3 billion ounces of silver in resources and close to 40 million ounces of gold resources. Long-life assets that give us the flexibility to extend over a long period of time, a quality production.
Healthy margins, as you can see, EBITDA margins of 45% backed by costs on the lower side in terms of gold and silver. Our disciplined approach to development as we concluded Juanicipio as well, one more for growth projects in this 12, 13 year of Fresnillo being listed in the London Stock Exchange.
The construction of Pyrites as well. And all of this within the sustainable approach that we have in our business. We are still to set some of the targets and objectives for our carbon footprint. However, we have already gone through some firm steps in terms of the conversion of our fleet in the open pit mines.
We have finished that conversion. And that means a lower carbon footprint but also an advantage on the cost side, especially good in this kind of environment in which energy prices have gone up.
Also, I’m glad to report that 50% of our energy consumption comes from renewable sources. So, those two firm good steps before we continue with our analysis and in order to be able to set our ESG targets in terms of carbon objectives for the company. I’m sure you will appreciate the strong balance sheet we have, cash generation by our operations. And as we post positive free cash flow of close to $270 million last year, which made us finished with a nice cash position.
Next, please. On the HSECR, we continue to monitor COVID and COVID how it evolves in Mexico. In October and November, very few cases across all of our mines. And then Omicron came and at the end of December and especially in January, we had in January, the same, but even higher number of cases than the whole 2021. So that came with a disruption to our operations. Of course, it was the same behavior in some of the places as well, less of the acute in terms of the health for our people but cause the same disruption across our operations. So we’ll continue to monitor this. And in the meantime, we continue with the same protocols across all of our mines, and that has passed somehow the peak at the end of January. And now we are managing much better that COVID fourth wave.
You will see that we continue to push across all of our operations and roll out our I Care, We Care philosophy. And you can see that on the statistics in terms of the frequency of the accidents and severity as well that is coming down since 2017 to now. So we’ll continue to push that. And as I mentioned, in terms of the environment, I mean, especially on the conversion of our products to our dual system that is giving us two advantages: one, reducing our carbon footprint; and the other one, reducing our diesel consumption, which on this time is good for the cost side.
Water is always important in mining. Happy to report the water reuse efficiency is 79% in the year. And that will continue with analyzing some of the projects, especially in some areas like Herradura, in which water is essential source there. We are analyzing one more sewage water treatment plant project. Hopefully, we can complete it, and also to increase the water efficiency in our operations. And in terms of community relations as well, that is central in our strategy to be a good neighbor with all of the communities around our operations.
Next, please. In terms of the — some of the operational performance, level production in terms of silver. We fell a bit short of our guidance for 2021. However, on the gold side, the production surpassed the expectations last year. We posted an increase in our adjusted revenues, very much with higher silver prices and metal prices in general. I’m glad to report, as I mentioned, that we concluded our Juanicipio project. And we are just waiting for the tie-up to the electrical grid, something that we will report with more detail during the presentation.
Next, please. And in terms of the financial performance, as I mentioned, an increase in terms of the — across all of the most lines, gross profit 6.5% above to $937 million, the operating profit as well an increase to $667 million, quite an EBITDA, strong EBITDA, $1.2 billion, increase of 3.2% and the profit for the period as well, almost 17% up to $438 million. I’m glad to report as well a final dividend of $0.24 per share that would make an equivalent to $177 million, close to $177 million on the year.
And with that, I will pass the presentation to Tomas Iturriaga, our Chief Operating Officer.
Tomas Iturriaga
Thanks, Octavio. And again, nice to be here with you all finally after a bit of isolation. So I will give you some more detail on our operations. So we can move to Page 12, please. So as we have said in our update that we were impacted by some labor shortages in 2021, and to some extend this continue into 2022. So the COVID, Omicron wave has a very negative impact in our absenteeism rates towards the end of the year, and we continue to see the impact as of February still this year.
Positive cases started to increase in December, had a very high peak in January. And in February, we still see some 400 cases — active cases of COVID, Omicron. And that in addition to the positive — the close contact isolation cases that I don’t — for a very high rate of absenteeism due to this.
So I think we have gone through the worst, March is still coming down. So we’re getting back to normal, so we cannot predict what’s going to happen next. So we are being cautious. We will continue promoting the vaccination among our employees. Some 78% of our workforce is fully vaccinated as of now. We’ll continue applying various strict testing and quarantine protocols to prevent [indiscernible] in the operations. And that’s what we will continue to do to deal with COVID.
Now moving into the vacancies. So ever since our IPO, we have traditionally relied in contractors to make up a significant portion of our workforce. And the new law reform in Mexico restricted the ability to subcontract some of the labor, some of the works that we used to contract it. So what happened initially is that all this environment around the new labor created uncertainty in our contractors, and that increased turnover rates around the August or so time frame. So just the announce of it and uncertainty around it, created some stability in our workforce.
Then we are in line with our conservative approach to business. We, are now analyzing implications of the labor reform, we decided to tag development and for each work under the core business tag. And then we launched a program to bring those relevant contractors into our business as unionized employees, right? That was the initial plan.
Unfortunately, we did underestimate the number of contractors who would prefer to keep receiving the short-term financial benefits of being a contractor as compared to the long-term compensation that we have designed as a Fresnillo Plc employees, right? So we underestimated that. So we were able to attract and or retain that contractor labor for the west suppose to become our own employees.
So this led to a shortage of trained and experienced personnel and — because we traditionally, as I said, relation and contractors as well as equipment that also equipment provided by contractors that both led to a lack of equipment along with low utilization. So that’s what really impacted us in terms of personnel.
Now we have how do we deal with it? We have — we launched a very large recruiting and training effort last year. We have about — nowadays about 400 employees already recruiting and training to supplement the Fresnillo district, particularly. And the rest of the month have their own program as well.
I’m just referring to Fresnillo and Saucito because those were the sites that were suffering the greater impact last year. So — and like I said, we will continue to monitor and do all we have on to keep covering on the contract.
So moving to Slide 13, please, Gabi. So the Fresnillo, we had a good first half of the year where we saw recovery in production levels at Fresnillo. However, the second half was disappointing. Well, much of this difficulty was because of the labor shortages we just described caused by the pandemic and labor reform. But events — operational events at Saucito and Fresnillo also contributed to the lower production we saw in the second half and particularly fourth quarter, which was where we saw the most of the impact, and this despite a very positive performance in San Julián.
So at Fresnillo, really, the main issue we had was a short system in one of the main power lines were underground, which reduced our pumping capacity leading to excess water and also reducing our hoisting capacity in our shafts, which — and that long together with some ventilation issues that we had in the mine impacts at the end of our mining and development rates. So — and really, that was the — what caused most of the impact towards the fourth quarter, I say.
To address these issues, what we have done is we have already commissioned run new pumping system 4,500 gallons per minute already operational. And we replaced the fail power line with a brand-new line as well. So with this, we are executing now for an impact from these two systems to the operations.
We will continue to address the workforce shortages caused by the COVID and labor reform with the training and the — with recruitment and training programs that I just described, and so with all that, we expect to see a better 2022 in Fresnillo compared to 2021.
The San Carlos shaft deepening is complete. We are now working on the infrastructure around the shaft. The zinc in itself is ready. So we’re just finishing the mine works install the washer and chutes and all that, that goes along with the shaft and it should be fully operational by the third quarter this year, which is going to help us get access to a large portion of reserves in 2022.
Now moving to Page 14 to talk about Saucito a little bit. So Saucito, in addition to the personnel issues, the other main problem or operational challenge that we had during the year was an increase of local seismicity in Jarillas West area. And that has started — so the seismicity increase throughout the year. So as the year progresses, we were forced to further slow down mining in that area of the mine. And that — what that did was really increased our need to develop more meters to get access to other areas of the mine, at a time, we didn’t have the people to do it. So that created a complex situation in Saucito and impacting the operations.
Also, the grade in the Jarillas West area is higher than that of the other areas available for mining. So we have a double impact there, lower tonnages and then lower grades because we were not able to access those spots at the Jarillas area. So we are — we continue to implement all the sensation required to deal with the seismicity. And with that instrumentation, what we do is we build that basis to — that we study the data to confirm the required sequence not to make the seismicity a bigger issue because of copper mining. So what it requires is a specific sequence of the mine that is the result of this story of these databases that we’re building.
We are also implementing a special or require ground support techniques to safely mine what we have in plan for this year in the year with Jarillas West area. So the operational impact in the 2021 issues that we faced in Fresnillo, Saucito in particular, those impacting development meters had also an impact in 2022 production guidance, which were accounted for in the guidance that you saw.
So 2022 will be a recovery year in Saucito in which we will gradually increase meters and tonnages in the mine as the year progresses and with that, we will position the mine for an improved 2023 year. Production in 2022 will remain in this level as you saw for 2021.
So what else are we going to do? And again, particularly in the Fresnillo district, which is where we have the biggest challenge. So in addition to our increased focus on recurring and training and retaining our people, we will continue with our efforts to improve the current contractor base performance and efficiency. We will also, as a new measure assigned a dedicated contractor equipment tandems and crews to the development of our strategic ramps. So this is something that we have not done in the past, have a tandem and a crew dedicated to one brand as opposed to having that tandem and crew cycling around work in the mine.
We will focus them in on ramp for the next 12 months to 18 months. So we advance our ramps, our strategic ramps at a faster pace in the new month. And that’s going to be done in Saucito, Fresnillo and Juanicipio. And in Saucito, we will add also a fresh new contractor to supplement our development meters for the next two, three years.
Okay. Slide 15, please, Gabi. So just to briefly talk in San Julián, very strong year in San Julián, good performance there. We got good rates or better-than-expected rates. But we also managed there to put on the bonds despite the structural issue that we have with the lead conditioning tank at the start of the year. And despite two power outages in the year because of issues of the government providers. So yes, good grade, but also a good operational performance by the team.
Ciénega, operational in line with expectations. Herradura also a strong performance after 2020 with some limitations because of COVID. Herradura performed well according to expectations and we expect to see a good 2022 also in operations. Noche Buena entering the final stage of mining. We will stop mining at around Q3. We had some good news there, because we were supposed to stop at mid-year yet, we found some extra ounces in the edge of the pit. We’re going to mine until Q3 had some good low-cost ounces to Noche Buena production this year and continue with the mine closure that we have already started.
Slide 16 and then this is Juanicipio. So construction of the plan there is complete and was delivered on schedule late last year. And so what we are missing now is connection of the plant to the national power grid. And so that’s on the energy regulator to complete that connection. And we are working on that. This got delay last year due to first, the lack of personnel by the regulator due to COVID restrictions that they have on their offices, and also some extra equipment that they require us to install before being ready to conduct. So now we are expecting that connection to happen by June this year. So during the second half of the year, accounting for that, we will start the commissioning of the new plant there.
So as part of this connection to the power grid, we have four shutdowns scheduled in the district. We need to shut down for 24 hours Fresnillo and Saucito to be able to connect Juanicipio to the grid because the power stations, the super stations that are interconnected. So we have done already two of those 24 shutdowns, 24-hour shutdowns, so it’s progressing.
And like I said, a lot of communication, a lot of lobbying with the regulator, and we believe that this is going to be ready by June to mitigate that impact because we had accounted initially for a full-year of operation in Juanicipio that is not going to happen, but to somehow mitigate part of that we will be using the extra capacity of Saucito and Fresnillo to process Juanicipio ore in the first half of the year. And by the end of the year, if the commissioning goes on as per the schedule that we have defined, we should be able to ship 80% to 90% nameplate capacity in the plan. Once Juanicipio is fully operational, this will be a good addition of production at end, it’s going to help decrease our consolidated cost for the company.
So I think that’s what I had to share, and I will pass it to Mario Arreguín now — sorry, to Guillermo Gastelum, who’s going to tell us about reserves. Thank you.
Guillermo Gastelum
Thank you very much, Tomas. I’m very happy to be here and to share with you some words on the resources and reserves and also to share a high-level update on the exploration activity we are performing.
So Gabi, go to the next slide. First of all, let’s start talking about silver. We are posting a 1.2% increase in our silver resources coming from our 2.3 billion ounces that we have in resources. This increase was driven mostly by an important increase at Fresnillo almost 80 million ounces of silver and good grades and also by some good exploration results at the San Julián Veins at Guanajuato project. However, these numbers were partially offset by decreases at the San Julián disseminated mostly due to depletion and by a significant decrease at Fresnillo around 60 million ounces of silver resources.
This decrease of Fresnillo was occurred 2/3 of the 40 million ounces occur in the inferred resource. So, it’s not a big impact with this regard. So — and some other factors affecting the Fresnillo silver resources where the depletion of coals and somewhat decrease is due to the increase of costs. Talking about reserves, — we were not able to replenish our reserves, we are report —
[Technical Difficulty]
— reinforcing the notion that we have a very strong portfolio of assets all the way from the mine. You can take a look at the triangle there and a few numbers from — few names, I’m sorry, from the mine operation, Juanicipio development, the projects undergoing, studies for PEA to feasibility studies and some advanced exploration projects as well.
And a significant number of projects in the early stage of drilling, and all of this has been [Technical Difficulty] our team doing a prospecting work throughout Mexico, Peru and Chile are continuing to generate new projects for — and prospects for the future.
We have been — we have received approval for our 2022 budget of $180 million. More than half of that 55% will be spent to pursue the objectives of the inside the mine exploration.
And the rest, 45% will be spent by the exploration division and if we divided in the investment in our development in PEA feasibility projects, but very importantly, increasing the pace of exploration drilling in advance and early stage drilling while we continue to still — now all of our teams are back in the field in Mexico, Peru and Chile and the team are recognizing margin in something in the countries where we operate.
So, I would like to highlight that 2021 was a very intense year in terms of drilling. We drilled over 835,000 meters across all of our operations. 91% of those were devoted to either in-mine exploration or greenfield explorations that we are — brownfield exploration, we are conducting in the area of influence of the mines.
Happy to report also that our reserves — well, our gold reserves in the open pit operations are back to proven and that we have made significant discoveries of new Vein mineralization at Fresnillo, San Julián and Guanajuato, which look very promising.
So what we are aiming to accomplish in 2022 in the mines, this is not new to you. We will continue to upgrade, there are huge mineral resources we have and make an effort to convert them into the measured and indicated category and eventually into the service. And we’re making every effort to fulfill a couple of issues pending to go back to proven reserves in an underground operations.
As I said before, we will continue to work development PEA and feasibility studies at Orisyvo, Rodeo and Guanajuato as I described before. And this is a lot of excitement that we have by increasing the pace of exploration in some of the advanced exploration projects, such as Tajitos, San Juan and Candamena, all of them already have resources in excess of one million ounces of gold equivalent.
And also, we will accelerate the exploration in the most promising early-stage drilling. We have very promising projects there. You can see them in the list. And also, we will start drill programs for the first time ever in a number of very promising prospects and projects.
So, I think that having said that, I will finalize my presentation and hand the microphone over to Mario. Thank you very much for your attention.
Mario Arreguín
If you don’t mind, I’ll make my presentation from here. There’s no problem with the sound here. No. Thank you very much. Well, certainly, good to be back in London to have the opportunity to meet in person with all of you. It’s been two long years, so it’s good to be back with the investors and with our analysts.
I would like to start my presentation by showing you the income statement, which is shown in this slide here. And as you can see from all the yellow lines, all profit levels were up compared to last year. Gross profit was up 6.5%. Operating profit was up 2.6%. Net profit for the period was up almost 17% and EBITDA was up 3.2%. But what I would like to do is to spend a few minutes to talk about adjusted production cost, which went up by 16% or $176 million. I would like to tell you, which where the cost is behind this increase, which factors were outside of our control, and which factors were related to additional volumes being processed.
And I also would like to spend a few minutes describing what was behind the increase in gross profit to almost $60 million increase in gross profit. How much of that was due to higher prices or to the increase in volumes.
But before I go to that, I would like to spend some time in the next slide. As you all know, inflation is a very hot topic. It certainly was for 2021. And given the Russian and Ukraine conflict, it looks like it will continue to be a hot topic this year. So that’s why I decided to dedicate a little bit of time to this issue. And what you see here is on the bottom right-hand side is that our consolidated weighted average cost inflation was 9.55%. This is estimated based on a basket of goods and services consumed by Fresnillo and which are listed in the first row of this chart.
As you can see, in terms of specific weight, the most important one is contractors, which represents 32% followed by operating materials, 17.6%; maintenance and repairs, approximately 16%; and energy, electric energy and diesel account for approximately also 16%. So based on this specific basket, you can see that in terms of weighted average the one that had the most important impact was actually contractors followed by diesel and then operating materials. It’s important to point out that this inflation rate, if you will, is denominated in dollars. I’m sure you remember that an important part of our production cost is actually denominated in pesos. So we have to mix both the behavior of the exchange rate, together with inflation.
So in the case of labor, for example, there was an increase in terms of dollars of 12.9% in unionized personnel. But actually in pesos, the increase was only 6.5%. But when you consider the effect of the revaluation of the Mexican peso in dollar terms, the increase actually added up to 12.9%.
So with that in mind, we’re ready to move to the next slide, where we show a rainbow. And the increase in adjusted production cost is represented by the green bar at the far right, the $176 million. And here, we try to explain the different reasons behind this increase. So if we look at columns number one and two, here again, we talk about the effect of cost inflation in the first column, excluding the effect of the revaluation of the Mexican peso. And in the second column, we specifically talk about the effect of the revaluation of the Mexican peso.
So when you add these two columns together, you get the full 9.55% cost inflation, and that accounted for $102 million, which represents about 60% of the total increase in adjusted production cost. So by far, this was the most important reason behind. However, there were other reasons also.
And I would like to move to Column number six and seven for the moment. These increases are related to increases in volumes processed. In Column number seven, we’re talking about Juanicipio. As you know, we processed mineral from development works at Juanicipio. Behind that, there was a cost.
But of course, this will increase our revenues and this will increase our gross profit. So we shouldn’t worry about Column seven. Also in the case of Noche Buena, there were additional volumes processed in 2021. So that meant additional costs. But again, additional revenues and gross profits were behind this Column.
We should be a bit worried about the Columns three, four and five. Starting with Column number, I’m sure you remember that in Herradura we have to stop operations during five or six weeks in 2020 due to the COVID pandemic. And this year, in 2021, we were able to operate continuously throughout the year. So all this hauling capacity, if you will, was available fully this year.
Unfortunately, most of it was dedicated to holding waste materials as the treatment ratio went up, and that’s why you don’t see a full benefit of that additional volume. As a matter of fact, we had to move additional volume, which is Column number four, which was purely dedicated to the higher stripping ratio. So when you combine those two Columns, you get approximately $44 million just because of the increase in the stripping ratio at Herradura, which I think is important to point out.
In Column number three, we talk about the increase in haulage, increases in contractors, maintenance and operating materials. And here, we’re talking about the use of or consumption of these items. We’re not talking about inflation. And that represented $41 million.
And on the favorable side, if you will, the fact that we processed lower volumes in Saucito and Fresnillo, San Julián and Cienega that meant that we did not incur in those costs. And that’s why you see that will affect $43 million. Unfortunately, that decrease in cost will also mean this in revenues and gross profit.
So with this in mind, I would like to move now to the following page, where we explained the variation in terms of gross profit, again, the increase of $57.6 million in terms of gross profit, is represented in the green bar. And clearly, if you move to the left, you will see that the most favorable impact was driven by the higher metal prices.
Realized prices in the case of silver, went up by 16.9%, in the case of lead, prices were up 21.6%, in the case of zinc, 31.7% and marginally in the case of coal only 0.1%. So that those increases had a very favorable effect of $253 million, which means if everything had stayed the same, the increase in gross profit would have been $253 million.
But we also had, like I mentioned, Juanicipio coming in with mineral from the development works. That generated a benefit of $53.4 million. And also the fact that we had lower treatment and refining charges also had a favorable effect, approximately $37 million. So those were the three main favorable effects.
On the downside, if we move to Column number 11, I already spoke about the impact of cost inflation, including the revaluation effect, which had an impact of negative $102 million. Column number 10 talks about the reassessment of gold inventories that we have in Herradura, so that you will remember that in 2020, we found additional ounces of gold at the Herradura leaching pads. We continue to benefit from that in 2021, but the benefit was much smaller than the one that we had in 2020. And that difference accounts for this almost $58 million decrease.
Column number nine, we already spoke about. Column number eight, remember, when we spoke about production cost, we said that there was a reduction due to Saucito, Fresnillo, San Julián and Cienega, lowering their volumes. Well, that had a negative effect in terms of profit of approximately $41 million.
The higher depreciation in column number seven. The fact that new operations are coming in, implies an increase in depreciation that had a negative impact of $22.8 million. And we already spoke about the higher stripping ratio at Herradura. So I hope with this, you get a clear idea of which were the favorable and the adverse effects affecting our gross profit.
Moving now on to the lines below the gross profit. I think, the one that you should spend a few minutes on is the exploration expenses. There was — we spent $130 million during the year, which represents a 21% increase or a $23 million increase compared to the previous year.
And I thought it would be interesting for you to know how that $130 million are composed of. As you can see, operating units represented $57.4 million or 42%. The responsibility of this part of the exploration is Tomas’, our COO’s responsibility.
In terms of projects, prospects and regional prospecting, all of which fall under the responsibility of Guillermo, that represents, if you add them, $58.8 million, which is very similar to the amount that we use for the operating units. That represents 43%. And the remaining amount basically goes to concession rights that we paid to the government for $21.5 million. So with this, you get a general idea of how this money was used.
Moving on now to the cash flow. As you can see in the bottom part of the first column, we ended the year with $1.24 billion in cash, which represents an increase of almost $165 million compared to the initial balance of the year.
And, of course, the most important source of fund was generated by the operations, which is shown in the upper line, the first line, $1.21 billion, an increase of 3.4% compared to last year.
And in terms of uses of funds, you can clearly see that the most important one was CapEx, including mine development, which used $592.1 million, and I’ll give you details on that in a few minutes.
The second most important use was the payment of income tax and profit sharing. And you remember, we’re talking about provisional tax payments that were made in 2021, special mining rights, profit sharing, et cetera.
And thirdly, the most important use was dividends paid for $246 million last year. This was made up of the final 2020 dividend, which was paid in May 2021, $162.6 million, together with the interim dividend for 2021, which was paid in November 2021, which was $73 million.
Now moving on to the next page, thought it would be interesting for you to know how this CapEx for $592 million were used. And at the bottom, you can see that the most important use was the Juanicipio project, almost $250 million were used there.
In the case of Fresnillo, we used almost $104 million [ph], basically in mine development and mining works in the construction of the pyrites plant and also in the purchase of in-mine equipment. And in Saucito, we used $100 million, again, in mining works in the purchase of in-mine equipment and also in tailing some construction. Between these three units, that represents approximately 80% of the total CapEx.
And lastly, just very briefly showed you the balance sheet. Just to point out that we continue to have a very strong financial position with a strong cash balance. And if you have any questions, I will be happy to answer them during the Q&A.
Octavio Alvídrez
Thank you, Mario. Just to conclude the presentation before we go to Q&A. Next page, please, Gabi. Here, we have our projected production as we have stated in our production report at the end of January 2022. Our guidance is between 50.5 million and 56.5 million ounces of silver and on the gold side for ’22, 600,000 to 650,000 ounces of gold. You will see our projection for 2023, which is a bit lower than the previous release information and 2024 level silver production as well on the gold side.
Next, Gabi. In terms of the projection for CapEx, you will see a higher CapEx number for 2022. That is one more effect of the labor reform. We used to rely on the use of equipment by contractors and as we are having a fewer number of contractors, we need to purchase the equipment, and that is reflected in the higher number of CapEx for 2022. You will see still a chair on top of the bar, a chair of the CapEx from Juanicipio, although that is concluded, but I mean it’s still some payments to come, and the rest is sustaining CapEx that we expect to bring down the following years ’23 and ’24.
Next, Gabi. And then the project pipeline. As we mentioned, the Pyrites Plant is complete and is waiting for the energy to be sourced by midyear and Juanicipio as well. Juanicipio making a large contribution in terms of silver production, but also on the consolidated gold projects actually consolidated cost of the company as well. And then over the following years, we do have two projects lined up. One is Rodeo that Guillermo explained and the other Orisyvo expected on a conceptual basis, at the end of ’24 and ’25, adding in general terms, 300,000 ounces of gold in added these two productions.
Next Gabi. So to conclude, world-class silver production as well, and I would say quality production as we have the production size and also coupled with the cost at which we produce each one of the ounces. On the gold side, on the gold production, sizable production and will be increased, as we mentioned, later on with Rodeo and Orisyvo. We continue with the track of bringing in new quality operations into our portfolio with Juanicipio and the pyrites plant as an efficiency project in our Fresnillo District as well.
But it’s not only that. I mean, it’s the portfolio we have on the exploration side as Guillermo was explaining. Large bank in — land bank in Mexico and also in Peru and Chile, very prospective ground, will continue giving us good projects to bring on stream and then into operation from the near and long future.
And as I mentioned, all of that backed by our approach on the ESG and sustainable side, which is essential to the mining industry nowadays. And Tomas spent a good minutes explaining how we are bringing our operations back to a normal performance after what I — what we call a transition year in 2022, affected by a lot of external factors some out of our control. But we believe we have been now framed and we’ll bring a more normal operation.
And with that, we can go to Q&A, please. Yes, Jason.
Question-and-Answer Session
Q – Jason Fairclough
Hi. Could we spend a little time on slide 18, please.
Octavio Alvídrez
So let’s go to slide 18.
Jason Fairclough
So that’s the delta and the silver reserves. And I just wanted to make sure I fully understood what happened here at Fresnillo. So that’s a big change in silver reserves at Fresnillo. And I guess, the question is, is that it?
Like are you comfortable right, or is there’s still risk? Because if I look at the new reserve grade, it’s still above the grades that you’ve been delivering to the mill over the past couple of years. Same question, I guess, for Saucito.
Octavio Alvídrez
Good. Do you want to mention something, I would complement, Guillermo?
Guillermo Gastelum
Yes. There’s one unfortunately, this decrease in severities, as I explained came by lower — came by lower than expected — thank you, Patrick [ph], we sold in some of the infill drilling as we continue to mine some depletion number as well. And this change that our team made in the upper levels of the mines.
We have learned by the upper levels of the veins, of the veins, not the mines, of the veins tend to be more valuable, we have experienced problems with their development in mining in that part. So the team decided to tackle on this issue by being more conservative in the approach on the way we estimate reserves in the upper levels of the veins. So as I said, we cut the area of influence of the information by almost 1% to 5% to half of it. So that has minimal impact in the number of the amount of reserves available.
However, I would like to point out that we have talked in the past that the — all of our mines have a great exploration potential. So if we take a look at the other side of the slide, you will note that the Fresnillo exploration is delivering.
It increased the resources but almost 80 million ounces of good grades, and we will continue to work on these resources of good grade and eventually will be incorporated into the reserves. So that alone on itself, is a good proof that the Fresnillo has a good potential and has a way to improve the scenario in the short and medium term in the years to come.
Octavio Alvídrez
Let me add a few words on Fresnillo, Jason, and it goes along the lines of Guillermo mentioned. Increase in good resources because, I mean, we discovered good veins there with good grade in — but that’s on the resource category for Fresnillo. That offsets really the fall, let’s say, 1:1 in reserves. So it’s a matter of converting those new resources into reserves in the near future.
Yes, we don’t like the fall we’ve had in 31 million ounces of silver in reserves. But as Guillermo mentioned, as we were approaching with mining works in the top area of the veins, we were not finding, but we were expecting. So we readjusted that model, and that’s the main loss of those 31 million. But as I mentioned, good to report that we increased 79 million in resources higher grades. So that would mean that we have the opportunity to convert those.
In terms of the grade, not reaching the production grade, not reaching the reserve grade, we continue to work on that as we’ve reported two years ago. I mean, we have started analyzing the whole process, one being the — all the way from the sampling of the development works, the production stopes, measuring consistently the dilution there going all the way to the sample — the quality of the sample QA/QC, going all the way to analyzing our labs as well. What we are coming to is that we are somehow with more dilution than expected on the production side. And Tomas is keen to bring that under control. We have three years, three good years in Fresnillo bringing the grade up from 2019, 2020 — 2018, 2019 and 2020, closing the gap to the reserve grade and that’s something that we shall continue to do so. But I mean is something that we are still pending to concrete.
And on the Saucito side, yes, on Saucito, we increased the cut off Guillermo, from last year. No, we lowered our cutoff grade, and that made us increase the tonnage, but also — but decrease the grade and that’s the main effect. And that is on the reserve grade coming down. So it’s different to Fresnillo.
Jason Fairclough
Just to sort of finish pushing on this and then I’ll drop it. So if we look at Page 37, your guidance on the grade for Fresnillo for this year is $190 million to $210 million. So it’s called $200 million, so you’re still more than 10% below reserve grade this year. So what is the path back to reserve grade?
Octavio Alvídrez
Yes. Decreasing the dilution, Tomas.
Jason Fairclough
Sorry, how long is that next year? Is it five years from now? Is it never?
Tomas Iturriaga
No, it’s not never. It’s literally not about — so our dilution control process is sound, is good, is in place. We monitor that as part of our day-to-day operations. So let’s — that’s under control. It’s really development what we need to do to be able to catch up with grade. So to get in a schedule to the short term compared to the long-term grade reserve that is that is just development on the shaft, sinking of the shafts going to help to get access to that area of the mine where we have like I said, greater portion of reserve and good grades.
So I would say it’s really about development meters and 2022 and 2023 are going to be similar $210 million to above $200 million. And as we gain access to those areas with more development, we will be catching up with reserve rate basically.
Jason Fairclough
So is the issue in your — it’s not that you don’t understand the ore body, it’s that you happen to be mining in a part of the ore body that is lower grade?
Tomas Iturriaga
As of now, yes, part of that. And then also the dilution, part of it is operational. Part of it is some materials that have not been accounted as reserve. We analyze on — as we go along in the mining and even being lower grade, with the prices and the cost at the moment, we include that supplement production, so that lowers also the grade. So that’s because we now lag the flexibility that more development meters would give us to mine closer to long-term reserve schedule and grades.
Octavio Alvídrez
Yes, complementing Tomas, as we increase the development, we increased the operational flexibility of cost. We have a plan for the following years to decrease parallel. Right now, we are not in that position right now and that you were asking when. It may be two, three, to four years gradually bringing that to the reserve grade. So we need to work on increase of the development, which is, I mean, realistically would be over the next couple of years. Tomas is putting in place some actions already is to regain that operational flexibility and to reduce the amount of ore that is not to the reserve grade.
Now the reserve grade is a picture right now of the 10 years — nine years of Fresnillo in the following nine years. What we mentioned, and this is a double effect is that the model and the sequence that we have for Fresnillo points out to an increase in the grade reserve over the following years and then at the back of the nine years go down, okay? So we need to work to those model sequence in order to continue closing the gap to the reserve grade. Now let me tell you, the ounces are there, the ounces are being produced is a matter when you dilute about cost.
Jason Fairclough
Okay. Thank you.
Octavio Alvídrez
Yes.
Unidentified Analyst
Two questions. The first one is just to follow on from Jason on the reserves and resources. I see you reclassified the open pit resources has proven, but you still haven’t been able to do that with the underground. Can you walk us through why your auditor, I think [indiscernible] doesn’t feel that there’s sufficient evidence to support the reserves that you see in the underground mines, what do you need to do to change that?
Octavio Alvídrez
Yes. Guillermo?
Guillermo Gastelum
One auditor I mean look that we have made a significant improvement in the way we estimate our resources and reserves. We’re talking about this underground reserves. We have made significant improvement in the quality control, in the implementation — investigation implementation of the geotechnical models, house models, hydrological models, ventilation models, all of that. But they are still requesting a couple of issues I mentioned in my presentation. And those two issues will be despite the fact that we have the geotechnical models, they want to see geotechnical models used to produce stability assessment of the different parts of the mines using these geotechnical models in more in a systematic fashion like to use this model that we have and implement it to the different parts of the mine. So that would be one factor.
The use of the geochemical models, to assess the stability of the different areas. So that’s something that we do, but they want to see a system much more robust. And on the other hand, although we conduct our reconciliation exercises, they want also to see a more robust reconciliation procedures, which will add more detail and more frequency to the way when conducting these exercises. So these are the two pending issue auditors are requesting from us to go back to proven reserves in the underground operations. Okay. Hopefully that answers your comment.
Octavio Alvídrez
I mean if I may add to that, the other thing that we need to further advance this — we need to prove that we have sufficient levels of engineering in the long-term — in the life of mine infrastructure of the mine. That’s been bailing times, power supply, water management, geological, but not in the short term for the life of mine. So I would say that the quality of the geological modeling is good. So now to qualify as proven reserve in addition to what Guillermo said, we have to advance on that level of engineering that the regulator is required for that, by the way, we do have engineering. We do have a plan for life of mine. They want to see more progress on that in new year.
Unidentified Analyst
Okay. And just to follow-up on that. I mean, I think our side in the market has been struggling with the multiyear inability to achieve reserve grade, do you think the audit is going to require that you prove that you can achieve your reserve grade before they upgrade the status? Or is it purely the data that’s given?
Unidentified Company Representative
No, I don’t think that has to do, it’s really more about this infrastructure, engineering and the controls on the reconciliation that Guillermo described.
Unidentified Analyst
Okay, cool. And then the second question for Mario on the cost side. So if I look back at your cost and CapEx, if I look back at the midyear presentation, you were guiding to about $450 million of CapEx for 2022. That’s nearly $250 million higher. Can you quantify the cost savings you’re going to be gaining from investment in terms of dollars per year internal rate of return on the investment because that’s kind of almost like building a new mine? What are we going to get out of it?
Mario Arreguín
Well, as you saw on the slide, the most important part is going to see new Juanicipio project, right?
Unidentified Analyst
No, no, the CapEx delta on — you were guiding a midyear $450 million, it’s now $690 million. If I look at the delta, it basically comes from sustaining CapEx. You said about purchasing the equipment as part of the labor transition. What’s the dollar number or the IRR on that investment?
Mario Arreguín
Well, that’s — if it’s sustaining capital, it will just maintain the operations.
Unidentified Analyst
You must be saving money. You said you’re going to save on contractor costs. What are we getting per year on [Indiscernible] of investment?
Mario Arreguín
The fact that we’re buying equipment in order to…
Unidentified Analyst
Correct. Yes. We’ll be modeling from 2023 of reduced costs to return on that CapEx.
Mario Arreguín
Yes. We replaced the equipment that was provided by the contractors, right. We haven’t done the calculation of the ROI. We can do it, of course. We had no choice. I mean we had to substitute that equipment. We have to substitute, otherwise, we would have reduced our operations. So I’m happy to do that calculation for you. But it will be higher CapEx, but lower OpEx.
Unidentified Analyst
And already possible to quantify that at this point?
Mario Arreguín
It is possible. Let me do the numbers for you, and I’ll get back to you. But again, we don’t have any choice. But I’m happy to do that calculation.
Unidentified Analyst
Okay, cool.
Octavio Alvídrez
And a quick comment there, just on the $450 million that you mentioned did not include any CapEx for Juanicipio, which I mean is just jumping into 2022. I mean the project is completed. The $450 million was just sustaining. So it’s $450 million compared to the $620 million actually, something like that.
Unidentified Analyst
Okay. So about $200-ish million, okay. And just final one, I mean, just from a cost perspective, when you look at that in adjusted production costs or inflation number, with 15% increase in adjusted production cost last year, what we should be expecting this year? Volumes are essentially flat. So what should we be thinking of in adjusted production?
Mario Arreguín
About 8%.
Unidentified Analyst
8% increase. Okay. Thanks.
Octavio Alvídrez
We have actually concluded our negotiations with the labor workforce at 8%.
Unidentified Analyst
Even with further 125, it’s not just labor. There’s quite a few other parts of inflation.
Octavio Alvídrez
Considering all of that.
Unidentified Analyst
Okay.
Mario Arreguín
That’s in MXN in dollar terms.
Octavio Alvídrez
Again, it’s difficult at this point in time to see what the price of coal is going to get to. And if it’s temporary or not. I mean, if the price of coal continues to go up and it stays, immediately, we’re going to see higher diesel prices, that’s immediate. But in the medium term, of course, everything is related to the price of coal, and everything is fast forwarded, everything produced using energy.
So I think that’s an issue to be considered. So to answer your question, I don’t want to compromise, because I saw you taking notes 8%. In a few months, it will come back to — within our budget in October, last year and in a revised budget in January this year, we presented that to the Board, it was approved. But that was before this problem between Ukraine and Russia.
And that’s where the 8% came out. So I do want to be very honest with you, who knows what’s going to happen, really. The only good thing about this is that together with that increase, you also see an increase in the price of gold and silver. So hopefully, our margins will even better. But, please don’t quote me on that 8%.
Tomas Iturriaga
Sorry, Alan, your question.
Unidentified Analyst
Yes, actually following up a little bit on that. Can you just remind us about how you’re procuring your energy? Is it completely spot? Or is it — are the prices sense?
Tomas Iturriaga
It’s basically stock prices.
Unidentified Analyst
Okay.
Tomas Iturriaga
…the government is still —
Mario Arreguín
But I mean the 50% that are coming from the sources from renewable sources that has a more stable than really the spot price, the other 50%.
Unidentified Analyst
The generic COVID impact, how disruptive will that be to Q1 production? And how much of your full year guidance takes into account a weaker start to the year because of that?
Octavio Alvídrez
Yes. So we mentioned, and as Tomas mentioned, I mean, the lack of personnel is what is affecting most of our operations right now, and some operational issues at Saucito generic. But I mean, we believe and we have the program in place to recruit is difficult in this type labor market. But the three first quarters of the year, we have a program to be fully staffed at our underground operations. So the fourth quarter should be normalized. And then on the open pit mines, was as the first quarter, but not to the extent that with the underground mines. So you will see first quarter not good and the underground operations and then gradually increasing the performance to a four-quarter norm.
Unidentified Analyst
So guidance is comfortable with the fact that 3,000 people have those at least a week in Q1?
Mario Arreguín
Yes. So those effects are accounted for in the guidance you’re seeing in 2022.
Unidentified Analyst
Okay. And then Rodeo or Orisyvo, when would those go up for Board approval this year?
Octavio Alvídrez
We are finishing our conceptual analysis, and we will start pre-feasibility this year. So the pending — Rodeo is an easier one than Orisyvo, of course. We will see if with the pre-feasibility, the we can present that for Board approval for otherwise, we’ll go to a feasibility on Rodeo. If that happens, that would be next year and then you will have two years for contraction.
Unidentified Analyst
Okay. Thank you.
Octavio Alvídrez
Okay. There are no other questions here. We can try from the conference call.
Operator
Thank you. [Operator Instructions] We do have a question coming through from the line of Krishan Agarwal calling from Citi. Please go ahead.
Krishan Agarwal
Hi. Thanks a lot for taking my question. A bit of a follow-up on Dan’s question on cost. So just to clarify, the current positioning is that the guidance is sort of 8%, and we’re not quoting you may on that, but just making as a number to work with. So — and then that works out to close to $100 million of increase into the adjusted cost base for the year 2022. But then you also said that the CapEx increase is primarily due to different purchases going into the sustaining CapEx, but then you will end up a little bit of cost in second half of this year. So is there any kind of a possible scenario that although the inflation adjusted costs go up, but because you have cost savings coming through from — in the OpEx, the adjusted cash cost remains sort of broadly flat on an absolute dollar number?
Mario Arreguín
I’m not sure I understood the question.
Gabi Mayor
Sorry, Krishan, you were a bit — the sound was not very good right now. Can you please repeat the question very quickly?
Krishan Agarwal
Yes. So the crux of the question is the CapEx increase, is that going to offset the inflationary increase in the cash cost?
Mario Arreguín
If the CapEx increase will offset the inflation somehow. To start yes, but not immediately.
Octavio Alvídrez
It will go directly to the contractor cost that we currently have. I mean, we are investing in equipment to substitute the equipment that the contractor has. The contracts typically would charge you for the use and also the value of that equipment. So they do have a difference that they get to their business. So that is the one that we will offset through time investing in our own equipment.
Krishan Agarwal
Okay. Okay. Understood.
Operator
The next question comes in from the line of Amos Fletcher calling from Barclays. Please go ahead.
Amos Fletcher
Yes, morning guys. Thanks for taking the questions. The question I had was just around the level of vacancies at Saucito that you highlighted in one of the slides is still pretty elevated. Is there a risk that in order to address these vacancies, you need to increase overall the levels of pay that you’re giving your workforce? And could that sort of induce increased inflation across the broader business?
Octavio Alvídrez
Well, we are — I mean, as we mentioned, I mean, it’s very — it’s been tough to recruit personnel in this type labor market. On general terms, we are still managing with our payment scheme for our workforce to bring some new employees on board. However, where we are working is on the variable incentive schemes in order to maintain the productivity of the contractors that we were using widely at Fresnillo mines. But that will come with additional productivity that what we are working.
Amos Fletcher
Okay. Thanks. And then, yes, I guess I just wanted to explore slightly what customer’s [ph] were talking about around you were saying in terms of oil price exposure, it flows immediately into diesel prices. Is there any lagged flow-in of oil prices into, for example, your electricity costs or any other areas? Thanks.
Octavio Alvídrez
Yes. In the case of electricity, what the government charges is typically based on their own cost of generating that electricity and a lot of it is generated using fuel oil. So if the price of oil goes up, that would automatically translate into a higher price of electricity.
Operator
The next question comes in from the line of Tyler Broda calling from RBC. Please go ahead.
Tyler Broda
Thanks. Thanks for taking the call. Just a follow-up on more talk about Dan’s question, just on the CapEx. So just to be clear, so it’s $135 million of new CapEx effectively for replacing the contractor equipment. Is it fair to say, I’m just thinking ballpark that it’s about — you get about, what, 10% charge on that is what the contractors you’re charging you? So is it like a $20 million impact to us? And I guess I can just give a bit more clarification on that.
And then just second, I guess just on a wider basis, what is the difference in terms of, I guess, the combination of both costs and productivity between your old workers and the contractors. I mean, is this going to be higher cost coming out of this or lower cost? Or how do you — once you have the new equipment in place? Or how do you benchmark that? Thanks very much.
Octavio Alvídrez
Okay. Yes. I mean, the investment we are doing in equipment, of course, will pay off in the following years as we have less of a use of contractors, as we mentioned. We owe you that more concrete projection, let’s say. But on the other side, you’re right. I mean, we are suffering now and that is included in our projection, not only for this year but also for next year.
In terms of the one, when you recruit, you have to go through a training period for non-experienced people. And that is included also in our projection for this year as we are recruiting the number of people that Tomas mentioned. But also on the productivity side, this is correct as well, your comment.
The contractors have a different team, and they are more productive than the crews that we have of our own personnel. So we are — we would need to work to, again, to achieve those productivity levels. And that also is projected is included not only for 2022, but also for 2023.
Tyler Broda
Okay. Thanks very much.
Operator
There are no further questions on the audio line.
Octavio Alvídrez
Okay. Another question over here. Otherwise, I would like just to take one those in the line, and this will be for Mario as he has not had enough question. Can you provide how level approximation of which costs are likely to be more transitory and which have to be more persistent and then give a sense of the scale an increase expectedly? This comes from Kieran Hodgson. That’s an easy one.
Mario Arreguín
That’s an easy one.
Octavio Alvídrez
More transitory and by more permanent.
Mario Arreguín
So I’m hoping that the oil price is transitory that is pricing then gradually, it starts coming down. If that is the case — that would agree with as and then you might have spiked and then it eventually comes down again, that will drop our costs, who knows really.
Octavio Alvídrez
Okay. One more quick one. Peter Lowry, can you please comment on the regulatory situation in Mexico regarding royalties and taxation?
Mario Arreguín
Yes, that one is easier. We’re not expecting any additional royalties for taxes from the Mexican government. We feel very comfortable in saying that because the precedent has been quite strong in terms of committed to not increasing taxes in royalties. We already paid quite a bit of royalties and quite a bit of taxes. So we don’t believe that there will be any changes in that regard the short term.
Octavio Alvídrez
Okay. And the last one for him is where do you think is the appropriate balance sheet capital structure? You issued other debt and the group should be able to carry net debt. So will you take on a reasonable level of debt to improve returns to equity?
Mario Arreguín
Well, we’re actually planning to maintain our current debt level. But as you know, we have a maturity coming up actually next year. Our plan is to resume that loan at those notes that are due approximately $320 million not increase for similar renew those notes. So that’s for a 30-year note. But we’re not taking on increasing either, just maintaining the load that we have right now.
Octavio Alvídrez
Okay. Two last questions from Chris Huang [ph], is the COVID situation in Mexico returning to a more normalized situation?
Yes, Chris, we had a peak, tremendous peak at the end of December and January, really. And as that has peaked in January and February, that’s dropping drastically. So if we don’t have any other variant and Mexico should be the same behavior as in some other countries, I mean, that will come to a more normalized situation.
And the last one, where will the power be connected as Fresnillo? I believe you mentioned it.
Mario Arreguín
Yes, it was in June.
Octavio Alvídrez
Yes, we are expecting in June — mid-year.
Okay. And with that, I mean, we will conclude. Thanking you all for attending the year-end results for Fresnillo. Thank you very much.
Mario Arreguín
Thank you.
