Dundee Precious Metals Inc

TSX:DPM

Earnings Call Transcript 2021-Q2

[Operator]

Good morning, and welcome to Dundee Precious Metals Second Quarter 2021 Earnings Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.I would now like to turn the conference over to your host, Jennifer Cameron, Director of Investor Relations. You may begin.

[Jennifer Cameron, Director of Investor Relations]

Thank you, and good morning. I'd like to welcome you to Dundee Precious Metals Second Quarter Conference Call. Joining us on the call today are David Rae, President and CEO; Hume Kyle, Chief Financial Officer; and Michael Dorfman, Executive Vice President, Corporate Development. After the close of business yesterday, we released our second quarter result and hope you've had an opportunity to review our material. All forward-looking information provided during this call is subject to the forward-looking qualifications, which is detailed in our news release and incorporated in full for the purposes of today's call. Certain financial measures referred to during this call are not measures recognized under IFRS and are referred to as non-GAAP measures. These measures have no standardized meaning under IFRS and may not be comparable to similar measures presented by other company. The definitions established and calculations performed by DPM are based on management's reasonable judgment and are consistently applied. These measures are intended to provide additional information and should not be considered in isolation or as a substitute for measures prepared in accordance with IFRS. Please refer to the non-GAAP financial measures section of our most recent MD&A for reconciliations of these non-GAAP measures. Please note that unless otherwise stated, operational and financial information communicated during this call are related to continuing operations and have generally been rounded. References to 2020 pertain to the comparable period in 2021, and references to averages are based on midpoints of our outlook or guidance.I'll now turn the call over to David Rae.

[David Rae, President, CEO, & Director]

Thanks, Jennifer. Good morning, and thank you all for joining us. As you've seen from our news release circulated last night, we delivered an exceptional quarter, achieving multiple records for operating and financial performance. Highlights from our results include excellent operating performance at our mines, which resulted in production of 85,000 ounces of gold and 10 million pounds of copper. Strong cost performance at all our operations with all-in sustaining costs of $605 per gold ounce. Record financial results, including free cash flow of $67 million and reporting $67 million of adjusted net earnings for the quarter. Closing of the sale of MineRP, which brought in proceeds of approximately $46 million, and we continue to build our financial strength, exceeding the quarter with a cash balance of $261 million.As you may also have seen from our news release earlier this week, we successfully closed the previously announced acquisition of INV Metals, adding the high-quality Loma Larga project to our development pipeline. This is a project that we believe fits extremely well with our core strength and our proven track record as an environmentally and socially responsible mining company, and that has the potential to add meaningful production growth to our portfolio. As we move forward, our approach to developing Loma Larga will reflect our firm commitment to the highest standards for engagement with local communities and environmental stewardship, and we'll leverage DPM's technical depth, financial strength, and our strong track record of delivering innovative solutions to unlock the significant potential of Loma Larga.I'm joining today's call from Ecuador, as we take the first step in engaging with the national and local stakeholders and our local team, and we look forward to continuing this engagement as we work to advance the project. In terms of next steps, we intend to explore further optimization studies at Loma Larga while continuing to advance the permitting process and will be taking a disciplined approach to project development. This includes minimizing upfront spend during the permitting process while engaging with local communities in line with international best practices and working to secure an investor protection agreement with the Ecuadorian government prior to making any significant capital commitments.Turning to a review of our operating performance. I'll start with Chelopech. Chelopech delivered an excellent quarter, producing 52,638 gold ounces and 10 million pounds of copper, which was a significant increase compared with the first quarter as a result of mining in higher grade zones and improved recoveries. Cost performance continues to be strong with second quarter all-in sustaining cost of $638 per gold ounce, which is below the low end of Chelopech's 2021 guidance range. We continue to focus on extending the mine life to our in mine and brownfield exploration programs. And during the quarter, significant effort was dedicated to testing conceptual targets within the Brevene exploration license as well with the completion of the scout drilling of several near-mine prospects, including Vozdol, Petrovden, and Sharlo Dere, which are expected to continue over the summer season. We continue to advance work to support and optimize infill and mineral resource delineation drill programs planned for Sveta Petka. That at the moment is an exploration license, but it's in anticipation of moving into the commercial discovery activity where the contract is anticipated to be signed off within the last part of the year. With mineral reserves that now extend to 2029, an updated mineral resource base and increase in mine and brownfield exploration drilling, we believe there is strong potential to continue our track record of mine life extensions at Chelopech.Turning to Ada Tepe, we've continued to deliver impressive performance, producing approximately 32,500 gold ounces in the second quarter. Ada Tepe also achieved strong cost performance during the quarter, with an all-in sustaining cost of $563, which is at the low end of its guidance range. This highlights its significant potential to drive free cash flow generation in our portfolio. We continue our exploration efforts around Ada Tepe with 23,000 meters of drilling planned for the year, including 9,000 meters of additional resource and conceptual target extension on the mine concession as well as advancing the Chatal kaya and other prospects on regional licenses. Drilling activities have been completed at Surnak and Synap, Kuklitsa. And at Surnak a new geological model has been completed in order to support internal technical assessments. We've now shifted our focus towards a significant camp wide surface data evaluation and compilation program, which includes additional mapping programs as well as geochemical and geophysical service to support exploration targeting exercises.Turning to Tsumeb, complex concentrate smelted increased in the second quarter, following the completion of the Ausmelt furnace maintenance at the end of March. The smelter processed approximately 59,600 tonnes of complex concentrate during Q2, and the cash cost per tonne was $400 significantly lower than the first quarter and more typical for Tsumeb, reflecting the increase of concentrate processed as the facility returned to a higher level of throughput following the maintenance shutdown in the first quarter. It's worth noting that while Canada and other parts of the world are seeing an encouraging decline in COVID cases, we are seeing a third wave in Namibia linked to the delta variant. At all of our sites, we continue to maintain the strict protocols, which we had in place throughout the pandemic to prioritize the health and well-being of our workforce and to provide support to our local communities. Recently, Tsumeb's included donations of medical supplies and oxygen produced from our smelting facilities, which then displaced medical oxygen before use in local medical facilities.In terms of future growth, we continue to advance our team project in Serbia. Earlier this year following the positive results of the pre-feasibility study we initiated a feasibility study and which we expect to complete in the first quarter of 2022, with the results to follow in the second quarter of that year. Drilling programs were completed at the Chocolate, Chocolate South, Frasen and Coka Rakita targets or located southeast of the bigger Hill deposit. This information is now being processed to support the preparation to the feasibility study. Plans for the next quarter include scout and target delineation drilling on the adjacent Umka exploration license, south of Bigar Hill as well as other regional early stage exploration programs.We also continue to pursue our growth strategy by evaluating additional opportunities that have the potential to generate strong returns and enhance the value of the company. In closing, overall, our strong gold production profile and significant free cash flow generation, combined with our operating track record and unique skills and innovation and building strong partnerships with local communities, position us well to continue delivering value for our shareholders. We are focused on demonstrating the potential of our portfolio to generate significant free cash flow and our commitment to deploying this capital in a disciplined manner. We firmly believe that DPM's strong fundamentals continue to represent a compelling value opportunity for investors.I'll now turn the call over to Hume for a review of our financial results and comment on our 2021 guidance and 3-year outlook, following which we will open the call for questions.

[Hume D. Kyle, Executive VP & CFO]

Thanks, David. Good morning, everybody. As David mentioned, we had very strong operational performance during the quarter, including record quarterly gold production, excellent cost performance and generated record net earnings and free cash flow. For the quarter, adjusted net earnings were $67 million or $0.37 per share, representing an increase of $0.13. Adjusted EBITDA was $101 million, up $23 million. These increases reflect a 9% and 69% increase in realized gold and copper prices, respectively, and lower G&A costs related to share-based compensation, partially offset by a weaker U.S. dollar. For the first 6 months, adjusted net earnings were $98 million or $0.54 per share compared to $0.52 in 2020, and adjusted EBITDA was $167 million, up $9 million. These increases were primarily attributable to higher increased metal prices, partially offset by the impact of the Q1 maintenance at Tsumeb, a weaker U.S. dollar.And in the case of the earnings, higher income taxes. For the first 6 months, net earnings attributable to common shares were $108 million and included a $21 million gain from the sale of MineRP as well as mark-to-market losses on our Sabina warrants and deferred income tax adjustments related to unrealized losses in respect of Sabina shares, none of which are reflective of our underlying operating performance and are, therefore, excluded from our adjusted earnings. From a cash flow perspective, funds from operations for the second quarter and first 6 months, which represents cash flow from operations before changes in working capital were 85 and $184 million, respectively, up 18 and $22 million compared to 2020. Free cash flow for the second quarter and first 6 months was 67 and $118 million, respectively, up 7 and $8 million compared to 2020. These year-over-year increases reflect the continued solid operating performance from Chelopech and Ada Tepe, higher realized gold prices and copper prices, including the fulfillment of the prepaid forward gold sales at Ada Tepe, which was completed in December 2020, partially offset by Tsumeb's Q1 maintenance shutdown and higher cash outlays for sustaining capital expenditures in line with the mine plans.Turning to our consolidated cost measures. We continue to deliver strong cost performance, achieving an all-in sustaining cost of $605 and $583 per ounce for the second quarter in first 6 months. These represented a decrease of 17% and 12%, respectively, due primarily to higher copper byproduct credits and lower allocated G&A expenses, partially offset by a weaker U.S. dollar and higher cash outlays for sustaining capital expenditures. At Tsumeb, cash cost per ton in the second quarter was $400, up $55 compared to 2020, due primarily to a weaker U.S. dollar and lower acid byproduct credits as a result of the timing of deliveries. For the first 6 months, cash cost was $550 -- $558, I should say, up $206, reflecting the impact of the Q1 maintenance shutdown and the fixed cost nature of the facility as well as a weaker U.S. dollar.From a capital expenditure standpoint, sustaining capital expenditures incurred in the quarter and for the first 6 months were 12 and $29 million, respectively, as compared to 10 and $17 million in the corresponding periods in 2020. These increases were due primarily to planned maintenance at Tsumeb and the accelerated grade control drilling at Ada Tepe. Growth capital expenditures incurred in the first quarter and the first 6 months -- sorry, correction, during the quarter and the first 6 months were 4 and $6 million, respectively, and this compared to 1 and $4 million in the corresponding periods in 2020.Turning to our balance sheet. Our financial strength continued to grow during the quarter with available aggregate resources of $411 million. This is comprised of a $261 million cash position as well as $150 million of available capacity under our long-term committed revolving facility. We also have a liquid investment portfolio, providing additional upside, valued at approximately $58 million. This excludes IMV metals, which, as you know, as of Monday, we now own 100% of. From a risk management perspective, all of our key financial metrics and underlying financial exposures are well within our established tolerance levels. And as previously communicated, from time to time, we enter into hedges to manage cost metrics, but the primary objective of reducing variability and supporting the achievement of our guidance. For the balance of the year, we have hedged the currency exposure in respect of approximately 79% of Tsumeb's projected operating costs using a 0 cost collar structure, locking in a weighted average floor and ceiling exchange rate of $15.65 and $18.69, and we've hedged substantially all of the copper by-product price exposure, which forms part of our all-in sustaining cost at a weighted average fixed price of $3.77.Looking forward, as Dave mentioned, we're on track to deliver on our previously issued 2021 guidance in our 3-year outlook, which remains unchanged with the exception of growth capital expenditures, which we have revised to reflect the addition of the Loma Larga gold project. Our detailed guidance for the year is outlined on Slide 15 and with strong year-to-date performance, we're on track to produce 271,000 to 317,000 ounces of gold and 34 million to 39 million pounds of copper, achievement all-in sustaining cost in the range of $625 to $695 per ounce and smelt 200,000 to 220,000 tonnes of complex concentrate at a cash cost of approximately $458 to $520. With the acquisition of Loma Larga, we've updated our growth capital expenditure guidance to $21 million to $28 million, and this reflects an estimated $5 million to $7 million of costs that we expect to incur on this project over the balance of the year. Over the longer term, covering 2022 and 2023, the guidance that we've provided remains unchanged and can be found in the 3-year outlook section of our MD&A.In closing, we're committed to continuing to deliver value to our stakeholders. And when you consider the current share price, solid free cash flow generation, strong 3-year outlook, and a strong balance sheet, the case can certainly be made that we represent a compelling value opportunity for our investors. With our unique capabilities and track record, we are also well positioned to further optimize our existing assets and to realize the potential value of our development assets, including our newly acquired Loma Larga gold project. As we reinvest and grow the value of the business, we're also committed as part of our disciplined capital allocation to ensuring that we return capital to our shareholders and that these returns are underpinned by a regular and sustainable quarterly dividend, the most recent of which we announced yesterday.With that, I'll turn the call back over to the operator.

[Operator]

[Operator Instructions] Your first question comes from the line of Dalton Baretto with Canaccord.

[Dalton Baretto, Analyst]

A couple of quick questions from me. First of all, it looks like there was a decent bump in the cost per ton at both mines. And I'm trying to understand how much of that is currency in royalty driven, and how much of that is something more operational, if you will?

[David Rae, President, CEO, & Director]

Hume, did you want to take that?

[Hume D. Kyle, Executive VP & CFO]

Yes. I mean, I would say, yes, we are seeing an impact with respect to some costs, but the main drivers for the quarter and what we would expect for the year center around 3 aspects: power pricing, which is up significantly year-over-year, weaker U.S. dollar. And in the case of Ada Tepe, a higher royalty because as you may know or may recall, the royalty rate at Ada Tepe is a sliding scale based on prior year profitability, so that royalty rate increased. I think it was approximately 2.7% in 2020, and it's now at the higher end of the sliding scale at 3.9%, and there's a cap of 4%. So those are the 3 primary factors that are causing an increase in the cost per ton metrics.

[Dalton Baretto, Analyst]

Understood. And so on the assumption that the exchange rate, the power pricing, and the royalty rate don't change, can we assume that costs got to stay in this range on a per-time basis going forward for the rest of this year at least?

[Hume D. Kyle, Executive VP & CFO]

I think that's probably fair to say. I mean, we'll obviously look to reduce costs and offset some of that elsewhere through productivity and otherwise. But at this stage, yes, that's -- we are expecting costs to be higher in the second half of the year and why we've indicated that given the current backdrop, we're likely to be at the higher end of the range on those cost per ton metrics. Now having said that, the all-in sustaining costs that we report, which includes those cost pressures, is certainly well on track to achieve the midpoint or even perhaps the lower end of the guidance on the basis of the copper pricing.

[Dalton Baretto, Analyst]

Understood. And then just in terms of shallow patch's concentrate distribution, it looks like Synap processed about 60% of the concentrate produced by past this quarter. That's a bit higher than I was expecting. I thought you wouldn't minimize the amount of concentrate that came out of Tsumeb.

[Hume D. Kyle, Executive VP & CFO]

Yes. So there's slight timing differences between when Chelopech actually ships concentrate and when Tsumeb processes it. But when you look at it from a Chelopech perspective, this year, we did, in the quarter, we did send or divert some material to other smelters, other third-party smelters, whereas last year, all of it went to Tsumeb. And in the 6 months, we definitely have shipped less material to Tsumeb relative to last year. And for the year, we do expect to divert more material to other third-party smelters. So, we should see a year-over-year decrease relative to 2021.

[Dalton Baretto, Analyst]

Got it. But on an ongoing basis, then, what's a good number to assume in terms of the percentage of concentrate produced by Chelopech that gets sent to Synap? Is it 60%? Is it 30%?

[Hume D. Kyle, Executive VP & CFO]

I would say that probably something around 70%, 80% is a good number based on history. And it can and has varied year-over-year, and it all depends on the spot market that exists. So, wherever there's an opportunity for us to displace material, bring in additional third-party material to Tsumeb and divert it elsewhere, we're going to do that. But it's a difficult thing to really predict. But that's really the strategy. We've seen those opportunities. We've taken advantage of it, and it's tended to range between, say, 20% and 30%. This year will probably be higher, but it can vary.

[Dalton Baretto, Analyst]

Okay. And then just a couple of quick ones on Loma Larga now that the transactions closed. First question, to what extent do you anticipate having to optimize the INV feasibility study? And do you actually plan to release an updated kind of DBM feasibility study?

[David Rae, President, CEO, & Director]

It's a bit premature to be able to say that at this point. We see that there are some trade-off studies that we will be doing with an intent to optimize. And also, we have some opportunities to upgrade some of the environmental standards, for instance. And we can do that in a way that may not require at this counts to update the feasibility study. So I'd say it's a little early. We're busy doing the trade-off studies. We see there's some opportunity for operational improvements, some things which would make a meaningful difference to our sustainability objectives, energy utilization, greenhouse gas, climate change type of thinking, and other opportunity in terms of the overall value of the project. So we're working on that at the moment. It's going to be an activity, I would imagine, over the next 3 to 4 months to really get the priorities and opportunities balanced. The other opportunity here, which I know you didn't ask, but just pointing out. So Hume mentioned the cost projection to the end of the year. There's obviously some exploration opportunity here as well that we're considering in the course of our immediate actions in Ecuador.

[Dalton Baretto, Analyst]

Got it. And then just maybe one last one for me. In terms of the investor protection agreement you were looking for, are you starting from scratch in terms of discussions with the government? Or are you going to pick up where INV left off? And is there an existing framework you can work on?

[David Rae, President, CEO, & Director]

Basically, we're picking up where INV left off. We've been in consultation with the government, things are well on track, and we anticipate some news between -- before the end of the year.

[Operator]

Your next question comes from the line of Don DeMarco with National Bank Financial.

[Don DeMarco, Analyst]

Your cash balance is growing quite a bit. So you benefit both from the free cash flow and the MineRP disposition this quarter. Is there any chance that you'll revisit your capital allocation strategies potentially with higher dividends or NCIBs or potential other uses as your cash balance continues to grow?

[David Rae, President, CEO, & Director]

I mean I'll start with that and Hume. Yes, I'll start. But anyway, I think the answer is that, obviously, our capital allocation program is something that is a very healthy discussion with our Board at each meeting, and we're very conscious of the fact that we do have that building cash balance. Clearly, we have some needs for that cash going forward. But it's -- there is an opportunity to use both the NCIB and look at the dividend level. So at this point, do we anticipate anything we just released the information on the dividend for this quarter, but it is something that we look at. Hume, did you want to answer anything further on that?

[Hume D. Kyle, Executive VP & CFO]

Yes. I think I just supplement and say that, yes, something that we put the dividend in place. The primary objective at the outset was to establish a sustainable dividend over the long term. And obviously, from our standpoint, it's based on a long-term outlook. And over the last period of time since we implemented that dividend, there's no doubt that the environment in which we've operated has produced better-than-anticipated free cash flow levels that actually would have originally driven the dividend setting by the Board. So, I think we're obviously in a stronger financial position. We update the outlook on a regular basis. I think from time to time, the Board will revisit that decision. So I think, as you say, like there is an opportunity in future to potentially increase and/or supplement that dividend. And certainly, to the extent that we have a view that our shares are undervalued, there is the opportunity for us to do some buyback under our existing NCIB.

[Don DeMarco, Analyst]

Okay. And continuing with a previously asked question. You mentioned that the power pricing has gone up. Can you comment on just the power situation that your mines are in Bulgaria, how much it's gone up? And whether you expect this to be transitory and power prices coming back down or expect to stay elevated?

[David Rae, President, CEO, & Director]

Go ahead, Hume.

[Hume D. Kyle, Executive VP & CFO]

Yes. I mean, I guess what I would say is, at this stage, we would expect that they're likely to remain elevated. They can be seasonal. And if you look over the last 4 or 5 years, the levels that we're seeing currently aren't unprecedented. I think that the current spike up is reflective of carbon tax in Europe. So, it's difficult to say that they're going to return to the lower levels that we've previously seen over the last 4 years just because of the impact of the carbon tax. And so at this stage, I'd probably say that we're looking at -- if nothing were to change, we're probably looking at something in the order of a 30% increase in power prices that could be sustained, which we consume, I think it's something like 165,000 megawatt hours of power. So when you translate it, it's probably $3 million to $4 million of increased cost if things don't revert back to the historical average.

[Don DeMarco, Analyst]

Okay. That's helpful. Just shifting over to Loma Larga, then one final question. You're not spending a lot there over the next couple of years. But can you talk about the primary pushback that you anticipate in the permitting process? And perhaps how you can leverage some of your permanent experience at Ada Tepe to specifically address some of the expected challenges in Ecuador?

[David Rae, President, CEO, & Director]

So, first of all, just some numbers around the power, it's around 10% of our cost for Chelopech in 7% for Ada Tepe. You're trying to get a sense of the impact of that change. In terms of what's going on here with Loma Larga, there was a view that we would be able to get the permitting within 6 months. We think that is optimistic. And we've, as you know, have been saying 18 months to 2 years is, we think, something that's realistic. Now in terms of what we need to do, obviously, myself and the Vice President, Sustainability Nicky Hristov are here at the moment, we're going to be joined by Kelly Stark-Anderson next week. And willing to key to at the moment, but heading to Quinka, and the outcome of this will be helpful in terms of understanding our path forward coming in the due diligence that we've done, and we can see a need to engage more broadly with the communities and more consistently with the communities. So our intent is to go and listen to the needs. We know, for instance, that conservation of water and the areas in which Loma Larga would be developed and it's a sense to be ecological areas. It's not that we can't mine that appropriately. It's just that there are concerns that we need to understand and address directly. And that's going to take engagement with the key stakeholders at the community levels at the regional level and at the national level. So we see that as a process that we're going to accelerate over the time that I'm talking about with the permitting, such that by the time that we have the national permits, we'll be in a position with the support from the communities to then go ahead and develop Loma Larga.

[Don DeMarco, Analyst]

Okay. Great. And so is there anything that, in your experience in permitting Ada Tepe, there were similar challenges in some ways that you'll leverage that experience to apply it to Loma Larga?

[David Rae, President, CEO, & Director]

Yes, absolutely. So engage broadly, listen carefully to what people have concerns about. There's a strong appetite here for people or groups that come in that demonstrate best practices in mining. And I think there are some good examples already in Ecuador with, for instance, Fruta del Norte. And it's our intent to demonstrate what quality mining internationally can mean in terms of the success in engaging with communities and constructing projects such that everybody is backed with pride in the sense that this has been something that's generated value and outweighs any minor negative impact. So learning from Ada Tepe, yes, I mean what we did the thing that really made the difference was engaging more broadly, understanding the key concerns, working with innovation and technology solutions as well as the latest best practices. And as long as we do that, I feel that -- I feel very positive that we're going to be able to get good early traction and then really get to the true points of concern as we sort of go through that period I was talking about with the permitting with the government. So far, been here since Saturday last week, very, very happy with the commentary that we've had after meeting a number of government officials and different ministries and hearing from local stakeholders and looking forward to hearing more as we move to Quinka and the communities over the course of next week.

[Operator]

Your next question comes from the line of Cosmos Chiu with CIBC.

[Cosmos Chiu]

Maybe my first question is on Chelopech. Just quickly, I noticed that Q2 grades were up 3.85 grams per tonne, 1.02% copper. Could you maybe comment on that? And in terms of as well what we should be expecting for the remainder of 2021?

[David Rae, President, CEO, & Director]

Sure. Yes. So obviously, we did mention that there was some sequencing between the 2 quarters. So what happened was we had some areas that we were set to mine that sequence between Q1 and Q2. So hence, the difference in grade between those 2 quarters. I'll come back to the grade expected for the rest of the year in the moment. But in terms of what else has been going on, we've also been doing some work, which is looking at getting more consistency in our performance around the mine in total and specifically focusing on the metallurgical plants at Chelopech. And this is sort of -- it's an upgrade to our operating model and looking at how each individual in the organization can create greater continuity and efficiency in terms of performance. So all of these things have come together to change the grade between quarters and change the metallurgical recovery. And I'm not too sure if you noticed it, but this was a record total production quarter as well. So, if you add the production both from copper concentrates and higher right concentrates. So, it's sort of all of those things that are part of it now. For the balance of the year, I'd anticipate that a grade between the first and the second quarter because what you see is that the reason why there was a displacement was just a moving of all the stocks between quarters. That was basically at the average grade expected for the year. So take the answer in Q1, take the answer in Q2, I anticipate we're going to be somewhere in the middle of that range, then project to the guidance, and we do target mid-range. So, that should give you some sense of comfort as to where we can expect to end up.There was another sort of minor things. So in some areas, what happened was when we went in with our 20 by 20 meter spacing for the grade control drilling. And then we got into the stopes, we were actually finding ore early and at a higher grade than we'd anticipated. So in combination then, sequencing, improved recovery overall and a more consistent performance in Q2 than Q1 and also a slightly more positive reconciliation in Q2 than Q1.

[Cosmos Chiu]

That's great. Maybe my next question on that. The “I” word these days seems to be the new effort in mining. And by that, I mean, inflation David, and Hume. You've touched on power costs. You've touched on some of the other costs. But inflation wise in the mining industry, is it something that keeps you up at night? Are you seeing inflationary pressures in labor or any other areas outside of power?

[David Rae, President, CEO, & Director]

So cost of living increases, we're running at about 3%, typically at the month. So labor increases are running at around those numbers. We do have a slight offset with efficiencies in terms of the number of people that we have at the operations. In terms of other variable costs, our consumables, we're seeing similar but lesser inflationary pressures. So an example would be snowballs with the -- that coming out of COVID. There's obviously been some constraints in that supply chain. It's not affected us in terms of our production, but we have seen a 20% increase in steel costs and about a 10% increase in our key reagent costs. So cost of living increased 3%, 30% in energy, 20% in steel, 10% in terms of reagents.

[Cosmos Chiu]

Okay. And then how do you -- I guess, looking forward, David, how do you expect to manage that risk? Is that something that you can hedge against? Or how would you factor that into your budgets? How do you manage that cost?

[David Rae, President, CEO, & Director]

So we're actually just at the moment in our detailed planning for our 3-year outlook in our 2022 fixed number. So we're actually looking at exactly that. So how do we deal with that? We deal with that in a number of ways. So we're obviously continuously looking at optimizations and efficiencies and we're applying advanced technologies on the mill in terms of energy efficiency, water consumption, reagent consumption, what I came back to in terms of consistency of operation. That affects not only recovery performance, but effective utilization of all the consumables. A better grind control means that you're managing both power and steel consumption. So I would say that we're busy looking at this thing in more detail at the moment and seeing how we might change some of our focus on innovation, but as Hume said, not all of these things are going to be in and stay. We do expect there's going to be something where we're seeing a peak at the moment and anticipate greater supply and some competition in those prices coming down. Hume, I don't know if you wanted to add anything to that?

[Hume D. Kyle, Executive VP & CFO]

Yes. I mean, I guess, yes, some of these things are transitory, like just like where we see in the news like the numbers when you're comparing period-over-period are quite high in part because some of these areas and prices were at lower levels a year ago. So when you look at it over a longer period of time, the numbers aren't as stark as you might first think. On the power side, as I said, like, I don't necessarily anticipate nor are we banking on there being a reversion to sort of the historical mean. But for instance, in Bulgaria, which has largely been a closed power market, it is opening up access at the end of this year to a number of other markets. So that might help to support price decreases. But again, we just -- we don't know for sure. So what can we do? We can certainly look closer at our procurement. We can look at what we can do in terms of entering into contracts that might provide for lower cost over a longer period of time. And we just have to do everything that we can on a continuous basis to find ways to offset through productivity.

[Cosmos Chiu]

Yes. Sure. And then maybe switching gears a little bit here. Reading through your MD&A. Clearly, there is a not renewed, but certainly, there's a focus on exploration at both Chelopech and at Ada Tepe. Could you remind me in terms of the drilling here? How much of that is infill? How much is that is step out? And what are you targeting here from -- if I were to step back and look at it from 10,000 feet? Are you looking for incremental increases in terms of one or 2 years of mine life? Are you looking for replacement? Are you looking for that jackpot here in terms of finding a completely new deposit. Could you maybe comment on exploration for Chelopech and also Ada Tepe?

[David Rae, President, CEO, & Director]

Sure. All right. So let me start with Chelopech. So Chelopech does around 44,000 meters of underground drilling annually. It's a very consistent number. And 2/3 of that is step out, as you referred to it, and 1/3 is infill. So perhaps the best way to say it, though, is it's actually extensional rather than step out, and that's the underground drilling. So last year, we did, I believe it was 17,600 meters from surface at Chelopech. This year, we have 38,000 meters planned, and that's including picking up on our geological discovery, which we're anticipating will get the contract to move to the commercial discovery phase, which is going to be 1 year of activity on Sveta Petka. If you have a look at Ada Tepe, so there we're doing something which is not going to be a useful reference. That right off the bat. So this year, we're doing 217 kilometers of drilling, which is all of the grade control drilling for the balance of the life of mine. The reason why we're doing that is because we have found a good deal of value in our understanding the nature of the asset in terms of being able to be ready for metallurgical material, metallurgically different material coming into the plant to support recovery. And also to be able to put together a program, which maximizes mine recovery and grade control as well as maximizing the overall process efficiency and so on. So that's why we're doing that. And it's roughly $10 million of $5 million direct drilling and $10 million of analytical costs. So in terms of the extensional drilling, we're doing 23 kilometers of drilling, where last year, I think we did 11,000 off the top of my head. And that's focused on 2 areas, so that's immediately around the mine, and then it's up to 40 kilometers away in case of Chatal kaya. So all of that, outside of what I talked about with the 217 kilometers is extensional step out.

[Cosmos Chiu]

Great. Yes, that's very helpful. And then one last question. I ask this every quarter. And I apologize if you've already answered it. I got cut out a little bit during the call.Certainly, free cash flow was very good in Q2. How much of that came from Tsumeb?

[David Rae, President, CEO, & Director]

Hume, did you want to take that?

[Hume D. Kyle, Executive VP & CFO]

Like no free cash flow came from Tsumeb or very, very little in the quarter.

[Cosmos Chiu]

And is that the expectation for the rest of the year?

[Hume D. Kyle, Executive VP & CFO]

Yes. I'd say that Tsumeb this year is probably looking at, at best, like a breakeven cash flow situation. So historically, we've said that we can manage Tsumeb to a kind of a breakeven to maybe $10 million of free cash flow. Certainly, this year, it's going to be at the lower end of that range, principally due to the fact that it's a maintenance here. So with the maintenance that we took in Q1 and the extended maintenance, yes, we're not expecting Tsumeb to generate much, if any, free cash flow this year.

[Cosmos Chiu]

Of course. Those are the questions I have. Thanks again, David and Hume, and have a good weekend.

[Operator]

[Operator Instructions] Your next question comes from the line of Wayne Lam with RBC Capital Markets.

[Wayne Lam, Analyst]

Yes, just kind of following up on the other questions. Just wondering if you could maybe provide some more detail on the higher labor incentives that you guys had outlined this quarter. Just wondering if that was seen at both operations and are those more one-off type payments or kind of ongoing in terms of cost inflation?

[David Rae, President, CEO, & Director]

Go ahead, Hume.

[Hume D. Kyle, Executive VP & CFO]

I'm guessing that this is, in addition to Dave's comment, just in terms of normal course escalation that we're seeing in labor rates, which are sort of in the order of magnitude to 3%. I think the other thing that came through in the year is there was a higher cost that came through in 2021 as a result of higher LTIP payouts that were allocated down to the site. So last year, a very strong year. Payouts higher than previously expected and budgeted for. So that came through the year -- on a year-over-year basis, the LTIP payments that impact operations were higher on a year-over-year basis. So that would have been the other factor. Are they transitory? I hope not. I mean, I hope that we continue to perform well and our share price goes up and those payments continue to maintain at current levels or grow, but it's that aspect of it, you can't really predict.

[Wayne Lam, Analyst]

Okay. And just on that, are those payments accrued and then paid out annually, or is it paid out on a quarterly basis?

[Hume D. Kyle, Executive VP & CFO]

Like on an overall basis, we accrue quarterly as it relates to the mark-to-market impacts. We accrue those on a corporate basis quarterly, but we don't allocate them down to the sites until they're actually known, and they can be quite volatile. And so you don't really know exactly what to accrue or what's going to be paid out until the end. So when we actually realize on the step, the mark-to-market component gets allocated down in a quarter. So it's Q2 of every year that, that mark-to-market would flow through to operations, and it can be favorable or unfavorable.

[Wayne Lam, Analyst]

Okay. Perfect. And then just in terms of the third wave maybe and kind of the measures that you guys are putting in place at Tsumeb, kind of similar to the other operations, should we also anticipate an uptick in cash costs there in the back half of the year?

[David Rae, President, CEO, & Director]

No, I don't think that's fair to assume. So the uptick is already showing signs that it's decreasing. So it looks like it may have been relatively short. What happened was the first in South Africa and then into Namibia. We saw this new wave. And from being fairly open, things were closed down pretty rapidly, travel between the major centers in the country were effectively shut down forcing people to wear masks. This type of thing. And that seems to have had the desired effect, schools were closed and so on. We haven't changed what we do at the site itself. We've maintained a higher level of control than watching distance in hygiene and this type of thing. In terms of the impact on costs, essentially, it's more of an impact on the efficiency in and around the sort of edges of the operation. So for instance, you have a team of people that's working on a particular activity. And then the following week, suddenly, you've got a number of them in isolation. It's not to say that they're positive. It's just that somebody in contact with them has been, and we take contract tracing very seriously. So it's more little sort of things around -- you thought you were going to get something done. It's going to get done a little bit later. We may have to bring other people in and sort of swap things around. It doesn't really translate too much into a cost issue. It's more sort of just one of those things on the fringe of the operation that makes that a little bit more difficult to require more management.

[Operator]

Your next question is a follow-up question from the line of Dalton Baretto with Canaccord.

[Dalton Baretto, Analyst]

Just one quick question for me. Now that we're halfway through the year, is there any thought being given to hedge out the cost of production next year?

[David Rae, President, CEO, & Director]

Go ahead, Hume.

[Hume D. Kyle, Executive VP & CFO]

Yes. I'd say we regularly look at all of our exposures, copper on a by-product basis is one of those exposures that we consider. So yes, we're considering it. But no, at this stage, I think on balance, we're inclined not to hedge. There's no formal plan to put on additional hedge. As I said earlier, we're -- we've hedged substantially all of our second half production. I think something very significant would have to change for us to put on any additional hedges. And at this stage, looking at our outlook that we have for the business, we probably see our all-in sustaining costs tracking in and around the levels that we put out. So there's no need for us to put on an additional hedge at this time.

[Operator]

There are no further questions at this time. And now I would like to turn the call over to Jennifer Cameron for closing remarks.

[Jennifer Cameron, Director of Investor Relations]

Well, thank you, everyone, for joining us today. If you have any further questions, please feel free to reach out, and we look forward to keeping you updated.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect. All presenters, please hold the line.