Price and currency volatility will continue to test miners

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Friday 24 May 2013 — Unprecedented price and currency volatility will continue to test mining and metals companies for the next few years as the sector approaches supply/demand equilibrium in many commodities, according to EY.

Demand for most commodities – driven by China and other rapid growth economies – has outstripped supply for the best part of the past decade, fuelling higher prices and encouraging new supply. As supply and demand now approach equilibrium, longer lead times in changing supply are leading to over and under corrections in supply, causing increased price volatility.

A white paper by EY, Price and Currency Volatility: Mining & Metals, released today, says the more progressive mining and metals companies are finding new ways to manage this volatility that will deliver benefits throughout the next 2-3 years when sharper and more frequent movements in prices are expected.

EY’s Global Mining & Metals Leader, Mike Elliott, says mining and metals companies will be preoccupied with reacting to the downside risk of price and currency volatility in 2013 and 2014.

Recent price volatility is underlined by the December 2012 reported results of the large diversified mining companies, in which mineral price movements accounted for 79% of the US$25.6b fall in the period-on-period earnings.

“The knee-jerk reaction is to begin hedging again. However, for most, the opportunity to establish an effective hedge has passed and those that are enticed to enter into significant hedging may create problems for themselves during the next upswing during this period of volatility,” says Elliott.

Elliott says many miners may use put options to manage short-term price risk but these are increasingly expensive, and companies need to look at ongoing solutions to managing the risk through the shorter price cycles.

“Mining companies that can build flexibility into their business to respond to short term volatility can create a competitive advantage,” he says.

“The sophisticated modeling tools available now mean that miners can consider multiple scenarios to identify how and where volatility impacts the business, and identify in advance possible actions to optimize their returns.”

Actions might include being nimble with changes to cut-off grades and mining sequencing, increasing the flexibility of costs to become less fixed and therefore more variable, and challenging notions of scale.

“Miners need to improve the integration of mine and financial planning, and – importantly – increase the speed of mine planning to match volatility,” Elliott says.

“Companies also need to do a better job of communicating to their shareholders the changes they are making to increase flexibility and what impact that may have on future margins. Without this, shareholders will expect the worst – that a company is unable to capture the price rises but is fully exposed to price falls.”

“Investors in turn should be seeking to understand where value is being created through the introduction of greater flexibility in the companies they are investing in, because it will be a differentiator in bottom line results.”

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This news release has been issued by EY Australia, a member firm of Ernst & Young Global Limited.

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Contact details:

Megan Ball
EY Australia
Tel: + 61 2 8295 6427