Business risks in mining and metals 2013-2014
The focus of risk has swung
“CEOs and boards today are protecting returns and managing the interests of varied and often competing stakeholders. This is in stark contrast to just 12 to 18 months ago when fast-tracking production and capacity constraints were top of the agenda.”
— Mike Elliott,
Global Mining and Metals Leader
The twin capital dilemmas of capital allocation and access to capital have rocketed to the top of the business risk list for mining and metals companies globally, up from number eight in 2012.
These are strategic risks that threaten the long-term growth prospects of the larger miners, and the short-term survival of cash-strapped juniors.
Majors are balancing shareholder demands with long-term growth strategies
Risk 1a. Majors are balancing shareholder demands with long-term growth strategies
For larger miners, the rapid decline in commodity prices in 2012, rampant cost inflation and falling returns have created a mismatch between miners’ long-term investment horizons and the short-term return horizon of new yield-hungry shareholders in the sector.
Many years of high growth in earnings, cash flows and capital appreciation have attracted a different group of investors to mining. These investors have short-term investment horizons and are not as comfortable with the sector’s cyclical nature and its longer-term investment and return horizon.
This raises the question of how to balance the demands of short-term shareholders with those investing for longer-term returns. There is a profound risk that the decisions taken by mining and metals companies today could damage their growth prospects, destroying shareholder value over the longer term.
Risk 1b. Junior miners fight for survival
The dilemma for junior miners could not be more different. The dramatic and continuing sell-off in equity markets has starved the junior end of the market of capital at levels we have not seen in 10 years. Advanced juniors and mid-tier producers have been caught in the middle, exposed to a fragile balancing act between investors’ thirst for yield and low tolerance of risk.
The cash and working capital position of the industry’s smallest companies underlines the severity of the situation. Companies with a market value of less than US$2 million — about 20% of listed mining companies across the main junior exchanges — had on average less than US$1 million in cash and equivalents on their balance sheets at 31 December 2012.
Risk 2. Ensuring margin protection and productivity improvement
A decade of higher prices has concealed the impact of rampant inflation, falling productivity and poor capital discipline in the sector. Softening of commodity prices in an environment of escalating costs has had a major impact on bottom lines, heralding an industry-wide directional change from growth for growth’s sake towards long-term optimization of operating costs and capital allocation.
While the market has been rewarding any cost decreases, those that improve long-term value by being embedded and sustainable will prove the most valuable.
Alongside this, productivity in the sector has been on the decline for nearly a decade, across manpower, equipment, processes and logistics. This has impacted the sector’s input to output ratio. Those who have tackled margin protection early are increasingly turning their focus towards optimizing productivity through their capital structure, and more judicious use of labor and equipment.
These companies are also focused on using innovation as a means of enhancing productivity. The increased digitization of mines also means that firms can better monitor and analyze processes in order to understand why productivity is falling and to identify and employ better practices.
Risk 3. Resource nationalism remains prolific
This risk is as critical as it was last year, but other risks have exceeded it in the urgency with which they need to be addressed. In some respects, companies are becoming less sensitive to the shock of resource nationalism as it becomes increasingly prolific year-on-year.
Rising taxes and royalties, mandated beneficiation, government ownership and the restriction of exports continue to spread across the globe. As resource nationalism has become more endemic, mining and metals companies have become better at managing this risk.
There are some signs that the retreat in capital investment by the sector may see governments take a more considered and cautious approach. But the mining and metals sector must continue to engage with governments to foster a greater understanding of the value a project brings to the host government, country and community.
Our newcomer - Threat of substitutes
This horizon-watching risk is one to closely monitor as its most acute ramifications are being felt across North America. The US shale gas boom and the gas-for-coal substitution that has occurred was sudden and the impact unexpected, with global ramifications.
The first indication a threat exists can be seen in:
- Regulatory changes
- Commodity cost or supply issues
- Products with low profit margins and less dependence on quality and performance
- Environmental concerns
- Technology advances
Once substitution starts occurring, it is potentially irreversible as it could cause a structural shift in consumer habits.
Other top risks
Social license to operate has crept up the list to fourth position as activists become more powerful and vocal through the use of social media around concerns over climate change, competition for water and the impact mining has on communities.
Skills shortage slips to five as the deferral or cancellation of new projects brings temporary relief but staffing the massive current development pool still remains a red-hot issue.
Price and currency volatility sees lower commodity prices testing the viability of marginal mines in the face of increasing costs. The ramifications of poor capital project execution have largely been absorbed by the sector.
Sharing the benefits steps up a place as stakeholders increase their call for a bigger piece of the pie, despite lower margins. Infrastructure access continues to test miners as financing evaporates.
Top 10 risks over six years
Top 10 risks over six years