Business risks in mining and metals 2013-2014
The top 10 risks
1. Capital dilemmas - Capital management and capital access
"The capital dilemma varies considerably for different sized players. For the small players, it is all about limited access to capital, while for the larger players, who can raise low-cost debt with relative ease, it’s all about how they allocate it."
— Lee Downham,
Volatility in the market has seen access to capital and its allocation catapulted to the number one risk ranking. Both majors and juniors are being restricted from investing capital – the juniors through restricted access to capital and the majors through lack of permission to deploy it.
- For the larger mining and metals companies, the dilemma is how best to allocate capital.
The industry has entered a new era of focusing on margin quality over price-driven volume growth. Companies have to balance divergent stakeholder demands with the ultimate goal of maximizing returns.
There is a call by some investors for a structural shift in capital allocation strategies, with greater allocation back to shareholders to offset falling short-term yields. This has created a mismatch between miners’ long-term investment horizons and the short-term return horizon of dividend chasers.
Balanced communication with long-term messages will help reach and attract the long-term investors, and greater transparency will ensure the trust of all shareholders.
- Juniors face the risk of having access to sufficient working capital to stay solvent.
The pullback of investors from riskier investments in the junior end of the market has created a capital desert for this segment of the market that has not been seen in a decade.
The cash and working capital position of the industry’s smallest companies is so severe that many are not in a cash position to wait for market conditions to improve, with a rationalization of the market expected.
There is some hope in the form of private capital investors who are favoring juniors with more advanced projects.
2. Margin protection and productivity improvement
“High mineral prices concealed the impact of rampant cost inflation, falling productivity, currency appreciation and poor capital discipline. Current lower prices are revealing how much these have been dragging on margins for more than a decade. To remain competitive, these handicaps must be addressed.”
— Nathan Roost,
Softening commodity prices in an environment of high costs are continuing to squeeze margins. Companies have responded with sector-wide redundancies, mine closures and divestments of non-core assets. There is a significant shift in the market from growth for growth’s sake towards long-term optimization of operating costs and capital allocation.
There is also a renewed focus on improving productivity by removing inefficiencies across the organization that were allowed to creep in during the period of high commodity prices. Even a return to the productivity levels of labor and equipment that existed a decade ago would yield major benefits to margins.
3. Resource nationalism
“Resource nationalism remains prolific in resource rich countries, and while it continues to be a major sector risk, it appears to have reached a tipping point where it no longer is the surprise it once was, and companies are getting better at managing this risk.”
— Andrew Miller,
While still high on the risk radar, and metals companies have become more adept at managing resource nationalism. There are signs that the current environment of squeezed margins and risk aversion has prompted some governments to promote initiatives to attract mining and metals investment.
The footprint of resource nationalism has continued to expand and comes in many forms:
- Mandated beneficiation
- Government direct ownership
- Tax and royalty increases
- Restriction of exports
Miners have had to become more politically savvy and are factoring specific country risk into investment models. The most successful are:
- Building strong relationships with government
- Effectively communicating the positive impacts of mining
- Increasing the transparency of government payments
4. Social license to operate
“As the expectations of mining and metals stakeholders continue to rise, companies have to do even more to maintain a social license to operate. It is not a task that has a beginning and an end, rather it is an ongoing relationship that needs constant attentions.”
— Mathew Nelson,
The pressure on social license to operate (SLTO) remains, with increased activism, digitally connected stakeholders and politicians who need to respond to general consensus. New sustainability challenges arise quickly and can also morph into other issues.
Stakeholders are becoming savvier, while anti-mining sentiment continues to proliferate against a backdrop of community and climate change concerns. Meanwhile, regulators are increasingly seeking to fill the gap between community expectations and existing laws with increased regulation.
Achieving a SLTO is one challenge, maintaining it is another. The key to both is communicating the value through the concept of shared value.
The sector’s understanding of the potential of shared value is in its infancy, suggesting a real opportunity for addressing SLTO. Companies can find better ways to demonstrate shared value in a manner that draws attention to the benefits of their initiative.
5. Skills shortage
“There has been a short-term easing in the skills shortage crisis because of project deferrals and cancellations, but it remains a medium to long-term challenge especially in geology and engineering.”
— Louise Rolland,
While the urgency of the availability of skilled talent has been slightly reduced by a number of mine closures and the cancellation of new projects, the long-term challenge remains.
The difficult market environment of 2012 saw the sector experience layoffs at high-cost mines. As some companies discovered, job losses can affect social license to operate, create brand damage, increase indirect costs and result in higher turnover. Employment upheaval may actually accelerate the exit of workers from the sector.
However, with longer-term demand for labor still expected to trend steeply upwards, the shortage of skilled talent can be addressed by developing a more holistic framework by:
- Adopting creative and innovative approaches to access new pools of talent
- Leveraging technology
- Motivating, engaging and retaining existing skilled workers
6. Price and currency volatility
“As supply begins to catch demand, we expect a period of even greater volatility in mineral prices and producer currencies. The knee-jerk reaction is to start hedging again. However, for most, the opportunity to establish an effective hedge is past — new solutions are necessary to deal with volatility. Managing revenue and cost volatility in the short term will be a focus for the miners.”
— Jay Patel,
Unprecedented price and currency volatility will continue to test mining and metals companies for the next few years.
As supply and demand now approach equilibrium in many commodities, longer lead times in changing production are leading to over and under corrections in supply, causing increased price volatility.
Short-term commodity hedging is sure to be a feature of managing this risk but, for most, the opportunity to establish an effective hedge is past.
Companies must consider potential price and currency outcomes well beyond current forward curves and mine plans. Best practice in the current climate will include measuring uncertainties, probabilities and the impact of decisions on expected returns.
The next price upswing will give companies the opportunity to commence a hedging program that provides better protection from future downward price volatility.
7. Capital project execution
“There has been a growing trend in the cancellation of highly publicized mega projects over the last year, with others being delivered late, over budget or delayed. The underlying risk profile of mega projects has not changed, instead there has been a shift from scarce resources to scarce capital.”
— Claus Jensen,
While the mining investment boom is peaking, delivery of a record number of complex projects still challenges the sector – will there be more failures?
A key characteristic of how companies have addressed this risk is the increased involvement and accountability of executive management in portfolio management, project selection, size and scoping decisions. This is ensuring strategic risk management, critical in today’s world.
An accompanying focus on prudent project selection and planning is important, while other headline initiatives can include:
- Improved capex predictability
- Establishing a robust governance structure
- Contingency planning
Capital investment management and project delivery principles are becoming popular terms within the sector’s capital projects.
In an environment of volatile commodity prices, low profitability and mounting pressure from shareholders, future mega projects should be approved as programs with multiple projects. This will provide executives with more options for reassessment throughout the project life cycle, granting them much-needed flexibility.
8. Sharing the benefits
“We are now seeing increased demand from most stakeholders for a larger slice of a shrinking pie.”
— Mike Elliott,
This risk is characterized by a push and pull: more vocal stakeholders with increased demands versus falling commodity prices and higher costs. Stakeholder expectations need to be reset to the new market conditions and lower base of distributable value; however, those expectations lag the new reality.
Shareholders feel they have seen little return in a period of large profits and large reinvestment in high-cost, organic growth and low-value M&A. Despite the margin squeeze, 2012 and 2013 has seen a period of record industrial disputation and expansion of resource nationalism that sought to secure a large slice of a shrinking pie.
Organizations should take a long-term view of sharing the benefits and proactively manage stakeholder expectations. Initiatives include:
- Working with employees to improve productivity and provide a basis for real wage increases as a trade-off
- Obtaining acceleration in regulatory approvals as an offset to higher taxes
While stakeholder demands will naturally rebalance over time, those companies that communicate with their stakeholders to bring that rebalancing forward will create greater value.
9. Infrastructure access
“Access to infrastructure is a fundamental part of doing business in any market, and while the challenges remain more or less the same, the solutions are becoming increasingly creative and collaborative.”
— Mark White,
With mining and metals companies turning to new deposits in frontier countries, the lack of infrastructure is a substantial hurdle. High costs and capital constraints are creating an infrastructure funding gap where neither governments nor miners are able to fund all of infrastructure needs.
To fill this gap, companies are reassessing their needs and revising their strategies:
- Majors are being more selective in capital allocation
- Juniors are recognizing the need for collaboration
- Everyone is considering selling stakes in infrastructure assets
Newcomers include non-traditional financiers such as customers and equipment suppliers, typically from emerging countries and usually with government backing. Private equity is also showing interest and institutional investors have emerged. Governments are increasingly playing the role of supporter rather than investor.
With companies changing the way they view the control of infrastructure, the infrastructure challenge looks set to change. In so doing, a whole new set of sub-risks will materialize. A new model of risk transfer and retention will be necessary to unlock financing.
10. Threat of substitution
“As a newcomer to the top risks in the sector, threat of substitution has been transformational for the US coal market with global ramifications. For other commodities, it has the capacity to radically change their market should the right conditions prevail.”
— Bob Stall,
A newcomer to the top 10, substitution has the potential to be a game changer if your product is impacted. It has already dramatically transformed the US coal market and has the capacity to irreversibly change other commodity markets, should the right conditions prevail.
For single commodity organizations, or organizations where one commodity dominates the product mix/profit share, substitution is a very credible and looming threat, especially when the commodity’s recent price has been high or there is a regulatory push that affects its prolific use.
It is critical to respond to early indicators of a commodity threat. Mining and metals companies need to stay focused on government regulations, emergent technologies or price-driven behaviors and be active in preparing responses.
Building risk management to deal with this risk into current strategies can help prepare the organization for these events. The risk of substitution also highlights the importance of monitoring interdependent sectors.