E&Y - Business Risks Facing Mining and Metals in 2013/2014
Business risks facingmining and metals2013–2014
ContentsThe Ernst & Young business risk radar formining and metals 3Executive summary 4The top 10 business risks 101. Capital allocation and access 112. Margin protection and productivity improvement 193. Resource nationalism 234. Social license to operate 275. Skills shortage 316. Price and currency volatility 367. Capital project execution 409. Infrastructure access 4710. Threat of substitutes 50Top risks for commodities 54Under the radar 56
The Ernst & Young business risk radarfor mining and metalsThe risks closest to the center of the radar are those that pose the greatest challenges to the miningand metals sector in 2013 and into 2014.10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resource nationalism2. Margin protection andproductivity improvement1.Capital allocationand accessUp from 2012 Same as 2012 New entryDown from 2012
The business risk report Mining and metals 2013–20144The twin capital dilemmas of capitalallocation and access to capital haverocketed to the top of the businessrisk list for mining and metalscompanies globally, up from numbereight in 2012. These capital dilemmasare strategic risks that threaten thelong-term growth prospects of thelarger miners at one end of the sector,and the short-term survival of cash-strapped juniors at the other end.Risk 1a — Majors learning to balanceshareholder demands with long-termgrowth strategiesFor larger miners, the rapid decline incommodity prices in 2012, rampant costa mismatch between miners’ long-termshareholders in the sector.Many years of high growth in earnings, cashcomfortable with the sector’s cyclical natureand its longer-term and often counterhow to balance the demands of short-termlonger-term returns. There is a profoundrisk that the decisions taken by mining andmetals companies today could damage theirgrowth prospects, destroying shareholdertheir balance sheets at 31 December 2012.Risk 2 — Margin protection andproductivity improvementA decade of higher prices has concealed thethe sector. In 2012, the softening ofescalating costs had a major impact onimpairments and derating of company stockheralded an industry-wide directionalchange from growth for growth’s sakecosts and capital allocation.survivalThe dilemma for junior miners could not bemore different. The dramatic and continuingcaught in the middle, exposed to a fragileyield and low tolerance of risk.The cash and working capital position ofthe industry’s smallest companiesUS$2 million — about 20% of listed miningcompanies across the main juniorExecutive summaryThe focus of riskhas swung!Top 10 risks201301 Capital dilemmas — capital allocationand access (new in 2009)0203 Resource nationalism04 Social license to operate05 Skills shortage06(new in 2010)07 Capital project execution(new in 2011)0809 Infrastructure access10 Threat of substitutes(new in 2013)01 Skills shortage02 Industry consolidation(not a threat in 2013)03 Infrastructure access04 Maintaining a social license to operate05 Climate change concerns(under the radar in 2013)0607 Pipeline shrinkage(under the radar in 2013)08 Resource nationalism09 Access to secure energy(under the radar in 2013)10 Increased regulation(under the radar in 2013)2008Over six years
5The business risk report Mining and metals 2013–2014Rising taxes and royalties, mandatedthe restriction of exports continue to spreadacross the globe. As resource nationalismhas become more endemic, mining andmanaging this risk. There are some signsconsidered and cautious approach, but themining and metals sector must continue tocommunity.Our newcomer — Threat of substitutesbeing felt across North America. The USshale gas boom and the gas-for-coalsubstitution that has occurred was suddenand the impact unexpected, with globalcredible and looming threat of substitutionfor single commodity companies orcompanies where one commoditybe seen when there are regulatory changes,commodity cost or supply issues, productssubstitution starts occurring, it is potentiallyshift in consumer habits.Substitution has the capacity to radicallyand rapidly change their market should theexamples include aluminium for steel;palladium for platinum; aluminium, plastics,copper; and pig iron for pure nickel.Other top risksSocial license to operate has crept up thechange, competition for water and theimpact mining has on communities. Skillscancellation of new projects bringssees lower commodity prices testing thebeen absorbed by the sector, a recordamount of construction is still in progress.stakeholders increase their call for a biggerpiece of the pie despite lower margins, andinfrastructure access continues to test theSome old faces in the crowdHalf of the risks that were present six yearsago, remain as critical today. A sectorparticipant’s ability to mitigate thesechallenges can mean the differencecyclical nature of the sector and the sector’ssuch as scarcity premiums for inputs or highproducer currencies, will ultimatelyhigh costs will continue to take a toll oncompany margins until companies addresscosts and capital allocation. While themarket has been rewarding any costhas been on the decline for nearly a decade,impacted the sector’s input to output ratio.early are increasingly turning their focustheir capital structure, and more judiciouscompanies are also focused on usingto identify and employ better practices.Risk 3 — Resource nationalismexceeded it in the urgency with which theyneed to be addressed, bumping it back tothird place. In some respects, companiesof resource nationalism as it becomescontrast to just 12 to 18 months ago when fast-tracking productionand capacity constraints were top of the agenda.”Mike ElliottGlobal Mining & Metals Leader, Ernst & Young
The business risk report Mining and metals 2013–20146Thetop 10businessrisks for mining andmetalsCapital dilemmas — capital allocation andcapital access01Volatility in the market has seen access tocapital and its allocation catapulted to thenumber one risk ranking. For both majorsand juniors they are being restricted fromrestricted access to capital and the majorsthrough lack of permission to deploy it.companies, the dilemma is how best toallocate capital.The industry has entered a new era ofstakeholder demands with the ultimateshift in capital allocation strategies, withgreater allocation of capital back toshareholders to offset falling short-termalike promise greater capital discipline,shareholder returns. This has createda mismatch between miners’ long-termBalanced communication with long-termmessages will help to reach and attracttransparency will ensure the trust of allshareholders.stay solvent.has created a capital desert for thissegment of the market that has not beenseen in a decade. The cash and workingcapital position of the industry’s smallesta cash position to wait for market conditionsmarket expected. There is some hope in theprojects.Margin protection and productivity improvement 02Softening commodity prices in anresponded with sector-wide redundancies,market from growth for growth’s sakecosts and capital allocation.to creep in during the period of highthat existed a decade ago would yield majorResource nationalism 03While still high on the risk radar, resourcenationalism is not the surprise it once wasand mining and metals companies are moreparticipation in the sector. This may be byroyalties.
7The business risk report Mining and metals 2013–2014The need for a social license to operateand metals sector. Its consistent midpointranking points to its importance, as well asan understanding of what managing thisconnected stakeholders and politicians whoneed to respond to general consensus. Newanti-mining sentiment continues toproliferate against a backdrop of communitySocial license to operate04and climate change concerns. Meanwhile,the gap between community expectationsand existing laws with increased regulation.maintaining it is another. The key to both isThe sector’s understanding of the potentialinfancy, suggesting a real opportunity forskilled talent has been slightly reduced bya number of mine closures and thecancellation of new projects, the long-termchallenge remains. As supply increases(despite price reductions), the number ofskilled workers also needs to increase.saw the mining and metals sectorexperience layoffs at high-cost mines. Asaffect social license to operate, createbrand damage, increase indirect costs andchange, presenting the industry with awhole new set of challenges, longer-termdemand for labor is still expected to trendsteeply upwards. In fact, employmentof workers from the sector.Skills shortage05of skilled talent can be addressed byapproaches to access new pools of talentexisting skilled workersIn the short term, mining and metalsproposition to attract and retain staff.for the ongoing challenge of competing forskilled talent. Longer term, skill sets thatwill need to be met by an already thin-on-the-ground industry.While the footprint of resource nationalismhas continued to expand, it has also come inexport taxes and most recently the use ofsuccessful are building strong relationshipsmining and increasing the transparency ofotherwise direct their projects from thethreat of resource nationalism has also
The business risk report Mining and metals 2013–20148Price and currency volatility 06will continue to test mining and metalscompanies for the next few years as thesector approaches supply-demandChina and other rapid-growth economies —has outstripped supply for the best part ofthe past decade, fueling higher prices andencouraging new supply. As supply andlonger lead times in changing productionundercorrection in supply, causing increasedthroughout the next two to three yearsbumpy ride ahead. Short-term commodityhedging is sure to be a feature of managingthis risk but, for most, the opportunity toCompanies must consider potential priceand currency outcomes well beyond currentpractice in the current climate will includemeasuring uncertainties, probabilitiesand the impact of decisions on expectedplanningchange the corporate risk appetiteriskthe opportunity to commence a hedgingCapital project execution 07projects being canceled, with othersthe scarcity of project inputs. While theprojects still challenges the sector — willthere be more failures?A key characteristic of how mining andportfolio management, project selection,strategic risk management — critical intoday’s world. An accompanying focus onprudent project selection and planning isand contingency planning, to name a few.popular terms within the sector’s capitalmore emphasis be placed on understandingpressure from shareholders, future megareassessment throughout the project life08and higher costs. Stakeholder expectationsneed to be reset to the new marketconditions and lower base of distributablenew reality.
9The business risk report Mining and metals 2013–2014With mining and metals companies turningto new deposits in frontier countries, thelack of infrastructure is a substantial hurdle.High costs and capital constraints arecreating an infrastructure funding gapable to fund all of the mining infrastructureneeds.considering selling stakes in infrastructureassets.Infrastructure access09Newcomers include non-traditionalemerging countries and usually withshowing an interest and institutionalthe control of infrastructure, theinfrastructure challenge looks set tochange, and in so doing, a whole new set ofUltimately, a new model of risk transfer andretention will be necessary to unlock theA newcomer to the top 10, substitution hasthe potential to be a game changer if yourproduct is impacted. It has alreadydramatically transformed the US coalchange other commodity markets, shouldthreat, especially when the commodity’srecent price has been high or there is aIt is critical to respond to early indicators ofThreat of substitution10a commodity threat — such as new orMining and metals companies need to stayresponses. Building risk management todeal with this risk into current strategieshighlights the importance of monitoringinterdependent sectors.criticism of management and board2013 has seen a period of record industrialdisputation and expansion of resourcenationalism that sought to secure a largeslice of a shrinking pie.manage stakeholder expectations.for real wage increases as a trade-off orobtaining acceleration in regulatorydemands and are renegotiating supplyagreements. This entails the relationshipfocus to switch from short-term outcomesto exploit scarcity to a longer-term, morestrategic one.While stakeholder demands will naturallycommunicate with their stakeholders tobring that rebalancing forward will createdoes not sow the seeds of stakeholdermineral prices.
The business risk report Mining and metals 2013–201410The top 10business risks
11The business risk report Mining and metals 2013–2014Dilemma A — CapitalallocationThe mantra over the past decadehas been one of fastest, largest,smartest, underpinned by a then-and sustainability of Chinese demandand an investor preference fororganizations with the strongestgrowth pipelines. With increasingAsian demand outstripping supply,growth was the goal of most in themining and metals sector. It stood todominated by M&A (buy) to increaseexposure to growth as rapidly aspossible. As much of this was fundedof this priority. The sharp recoverythe preference in allocating capital toorganic growth (build) projects.bidding up the cost of constructing manysimultaneous projects and closed the supplywe enter a new era of focus on marginThe industry’s decision-makers face aThe perfect storm2012 and 2013 has represented a point ofdislocation and disruption for the miningand metals industry. Weaker metal prices,simultaneously been ploughed into majorreturn on many of these projects. Lowerconcern for credit ratings agencies andfor increased capital returns without amanagement.only be truly assessed in the fullness ofannounced in the 2012 reporting season.Around US$30 billion2of asset impairmentswere recorded in the December 2012reporting season by the top six majorsalone. The impairments represented thechallenges, and underestimated cost andChanging of the guardBeyond the multibillion-dollar write-downs,largest companies, including BHP Billiton,Rio Tinto, Anglo American, Newmontreputation for focus on cost control andalso in response to the need for a differentstyle of leadership to satisfy the market’sdemand for discipline and focus on cash2. Ernst & Young research, company reports.(8 in 2012)00.20.40.60.81.01.21.401020304050602006 2007 2008 2009 2010 2011 2012 2013 2014 2015Netdebt/EBITDACash from operations less CAPEX Net debt/EBITDA-20-10 ConsensusforecastsCashfromoperationslessCAPEX(US$b)110. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access01The capital dilemmas
The business risk report Mining and metals 2013–201412Humbled and disciplineda wholesale shift in rhetoric, declaringgreater capital discipline, a commitment toexample, has pledged focus, disciplinehighest returning assets, and a well-2014.3as the right person to lead BHP Billiton in a4He outlinedof importance.5It is not that the large miners cannotLee DownhamGlobal Mining & Metals Transactions Leader,Ernst & Youngterm, shareholders are expressing theirA capital strike — but atwhat cost?Widespread cutbacks in growth capex werealso announced, which, along with othertaken by Vale highlight the complexity andscale of the capital allocation challenge.Vale announced its intention to suspend itsRio Colorado potash project due toescalating capital costs that rendered theproject no longer in line with Vale’scommitment to discipline in capitalallocation.6disappointment with the decision has beenwell documented. Companies must manageshareholders but also of their multipleproject stakeholders, from mine engineersand business unit heads to hostagendas.can’t be penny-wise and pound-foolish.operate are critical to earning returns onreputation.”7Divesting to reinvestand recycle capital away from high-costassets and into high-performing ones.expect to see underperforming, high-cost orhigh-risk assets being marked for disposalreallocate capital.all about limited access to capital, while for thelarger players, who can raise low-cost debt with3. Rio Tinto FY results presentation, 25 February 2013.BHP Billiton press release, 20 February 2013.outperformance,” Morgan Stanley, 1 March 2013. Reuters, 11 March 2013.Total shareholder return — global miners vs. all sectors and base metals01002003004005006007008002003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013Long-term outperformance0204060801001201402011 2012 2013HSBC Global Mining MSCI World LMEX IndexNear-term underperformance
13The business risk report Mining and metals 2013–2014Structural change demandedstructural shift in capital allocationstrategies that would see an increase inhigh-risk M&A or low-returning capex.Underpinning this is a concern that thecurrent assurances by management areallocation of capital to shareholders, it willbe important that the performanceThere is concern that the pendulum mayswing too far, raising the possibility ofin new supply, as traditional capitallong lead exploration funding. There isprofound risk that the decisions taken bymining and metals companies today couldproduction, with supply now catching upwith demand. It is forecast that supply willexceed demand for the period 2014 to2016. With a market in a short-term frameof mind and as spot pricing will remain soft,there will be little appetite for capitalallocation to new copper production. ThereShort-term gains versus long-term growthbeen top of the agenda for boards, whetherwe look at capital allocation priorities in2007 or 2013. The mining and metalsirreconcilable mismatch between theof shareholders.lower-cost, higher-margin projects —something that the market may not be fullysector.Comments by Cynthia Carroll, outgoing8challenge that mining and metalscompanies face in 2013.production from 2017. The projectsconstruction today.Furthermore, competition is emerging fromwealth funds and state-owned entitiesstronger position to make long-term,that are being put up for sale) for thosewith the capital, appetite and ability to dodeals, which may also include well-risk that when the time comes for them toreturn to the deal table, the cost of capitalpeak and with capital management likely toin 2013, those who best manage theshort-term needs of shareholders withwinners.patient,” Mining Journal, 28 March 2013. “BlackRock cuts BHPBloomberg,29 March 2012.“Some of the decisions (companies) areterm strategy but are you going to makemoney from it in the next three years,BlackrockAnglo American“It’s not an industry where you can reactyesterday. The (industry) context haschanged (and) may be the shareholderbase must also change. It will needmore time and patience.”
The business risk report Mining and metals 2013–201414Demonstrate discipline and rigorrisk against expected returnand assumptionsinternal lobbyingConsider all the scenarios on a consistent basisUndertake forward-looking scenario testingimpact, not in isolationconsider selling infrastructure or contract miningBuild in optionsdestination of capital outlaysoptionalitySteps companies can take tomanage this risk — translatingpromises into actionDiscipline and rigor needs to be exercisedwhen making capital decisions, perhapsprocesses and the underlying factors thatmeans for the short- and long-termprospects of the company.The market has also changed. Many yearsto the sector. This is incongruent with aoperating asset for 25 years or longer. Thisdemands of short-term shareholders withBalanced reporting that ensures the rightlong-term messages reach the longer-termthe exits.To this end, greater transparency inregains the trust of its shareholders.Stakeholder relations need to be carefullyconsistency of messaging and thebeing applied across all decision-makingprocesses.But, importantly, management must bemindful of not suffocating decisions throughtoo much process. The experience of strongmanagement teams should not go unheard,a combination of art and science is key inmaking capital decisions.Companies that display best practiceapproaches to capital allocation, andoutlined in the section below.
15The business risk report Mining and metals 2013–2014Dilemma B — Access tocapitalAccess to capital has becomea divided issue in 2012 and 2013.At one extreme, investment-gradeproducers have taken advantage ofunprecedented demand in the bondmarkets to raise record proceedswith historically low coupons. At theother, the dramatic and continuingsell-off in the equity markets hascritically impacted the availabilityof capital for the junior end of themarket. Somewhere in the middlesit the advanced juniors and mid-tier producers, exposed to a fragilebalancing act between investors’thirst for yield and tolerance of risk.The unhappy upshot of this situationis that access to capital has becomecritically restricted for those mostin need.Juniors in crisisErnst & Young’s two sector indices, MiningEye and Canadian Mining Eye, which trackthe performance of junior mining stocks onAIM and Toronto’s main and Venture18 months.near-term, high-yield opportunities, whichthe early stage junior mining sector simplycommodity prices. Instead, they are takinga step back, wait and see approach, optingto stay absent from the sector in theshort-term rather than make long-termadjustments to their return expectations.because junior mining companies cannotafford to take the same wait it outapproach. The exploration sector facesescalating operational costs andchallenges in 2013. Projects areincreasingly located in frontiergeographies, which can bring heightenedgeopolitical risk, infrastructure challengesand operating costs. Exploration andcomplexity, while projects are increasinguncertainty and lengthy arbitration processesare depressingly common, making for anprojects are changing.outcome.The demise of risk capitalstarkly illustrated by the near unprecedentedtowards the sector.exploration companies listed on the Toronto,TSX-Venture, Australian and AIM stockexchanges fell by nearly 30% in 2012companies raised less than US$1 million.Paul MurphyErnst & Youngof opportunity to issue can besmall, so you need to be readyto go when it opens up.”Relative performance of mining stocks (2012–13)020406080100120140Jan2012Feb2012Mar2012Apr2012May2012Jun2012Jul2012Aug2012Sep2012Oct2012Nov2012Dec2012Jan2013Feb2013Mar2013Apr2013May2013Mining Eye (AIM) Canadian Mining Eye (TSX & TSX-V)S&P/TSX CompositeFTSE AIM All-Share
The business risk report Mining and metals 2013–201416into the market signals the prospect ofthe near term. This is also supported by thehigh-cost desperation (last resort) fundingWith risk capital likely to stay absentrather than growth capital. Those withnon-core assets are making disposals totheir peers to share risks and costs, orthe sector altogether.of the industry is a process of naturalCritical cashThe cash and working capital positions ofthe industry’s smallest companies furtherless than US$2 million (which account forthe main junior exchanges1) had, onmining companies listed on the TSX VentureExchange had less than US$500,000 —of 2013 to restore widespread workingThere is some hopeThere is a healthier picture for the moreIt has transpired that non-traditional2012.2competition for capital between companies,cost attached. Such funding sources includeand non-syndicated loans. Strategicsecondary listings are still being pursued,fundraising through a widened shareholderalso being canceled where poor trading1. Based on reported cash balances of companies listed onthe Toronto, TSX Venture, Australian and AIM exchanges.metals,” Ernst & Young, 2013.2011 2012 Q1 2012 Q1 201301,0002,0003,0004,0005,0006,0007,0008,000Proceeds(US$m)2011 2012 Q1 2012 Q1 201302004006008001,0001,2001,4001,6001,800VolumeofissueEquity raisings by exploration companies — proceeds and volume (2011-Q1 2013)
17The business risk report Mining and metals 2013–2014undertaken by the majors in 2013.opportunities, but for deals to be done,The longer-term, industry-wide implicationsexploration should not be ignored. But thethe coming months.Quality in quantity — recordinvestment-grade debtthe major producers. Such was the demandcompanies issued new debt at yields nearor below where their existing debt wastrading. Mining and metals companiesthe repurchase of existing bonds, locking inlower coupons and extending maturities.sectors) remains strong. This fall inneed or desire among the mining majors toraise further debt, rather than anyAccess to capital is not at the top of the riskputting existing capital to better work.The mid-tiers — in demand butvulnerablesaw a 22% y-o-y increase to US$132 billion3a trend matched in the miningand metals sector with US$6.8 billionof bond issues accounting for 30% ofall proceeds raised (compared withUS$5.8 billion, accounting for 15% inin an otherwise capital-constrainedThomson Reuters, 2013.4. Bank of America Merrill Lynch US High Yield CorporateMetals & Mining index.of the crisis,4the mining and metals sector, which hasenabled mid-tier companies to raise capitalincreased risk attached to this asset class.A weakening of the economic outlook couldheightening the risk of increased cost ofcapital for companies.companies needing to raise capital atIn 2012, windows of opportunity to issuethese opportunities were issuers who hadpre-prepared and marketed theirdocumentation.US corporate bond yields — investment grade and high yield(BofA ML)Average spreads on corporate to treasury bonds — investmentgrade vs. speculative grade (Thomson Reuters)024681012141618202007 2008 2009 2010 2011 2012 2013Redemptionyield(%)US IGBasicIndustries US HYMetals&MiningUS HY10002004006008001,0001,2001,4001,6001,8002,0002007 2008 2009 2010 2011 2012 2013Spreadtobenchmark(bps)A+B-
The business risk report Mining and metals 2013–201418Steps mining and metals companies can take to respond to this riskThe challenge for junior companies is primarily one of knowledge,marketUnderstanding the short- and long-term implications ofdifferent funding types and their real costsCompeting for funds from a limited pool of increasinglytransacting on the best termsExplore and assess all options — do they meet short andall stakeholders, now and in the future? Is the trade-off betweenacceptable? What doors do they open or close to furtherfunding?fundingIf choosing to sell assets, consider selling early or face urgentseller documentationlonger be appropriate
19The business risk report Mining and metals 2013–201402 (4 in 2012)Margin protection andproductivity improvement10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand accessHigh costs continue to take a toll oncompany margins, forcing a shift inindustry mindsets from growth forgrowth’s sake towards long-termoptimization of operating costs andcapital allocation. According to Riocost base has risen by an average ofUS$2 billion a year since 2009.1Value creation is not about absolutescarcity premiums for inputs or thecurrencies, will self-correct as mineralbetter than their peers.Reacting to falling pricesThe decade of higher prices has led to aDrivers1Falls in mineral prices as supply hasclosed the gap on demandThe LMEX index (basket of LME base metals’ prices)22Scarcity premiums in the costs of inputssince 2008.33Falling gradesnow <4%.4 capital and labor45Poor capital project execution50% of all projects.56 currenciesThe Australian dollar, Canadian dollar and Chileanbetween 2005 and 2012.67Lack of cost containment disciplinegrowth in the future cost base.reduce production from high-cost minesand brutally strip out operating costs.Similarly, the marketing departments ofstructural situations of supply demandbalance for much of a decade. As one coalthan 100 people weeks to reduce costs by‘a dollar a ton,’ but one marketing personnegotiation.”Unwinding scarcity premiumsworkers, tyres, sulfuric acid, port access orconstruction contractors, and the only wayto secure supply has been to pay thelooking to renegotiate their long-termbuilt strong margins, take some of theinto these arrangements should be apriority. BHP Billiton has launched a globalcampaign to renegotiate contracts withsuppliers and contractors to adjust prices to7Thesupplier base.Cutting off uneconomic gradeMining and metals producers are not knownfor their speed to react to new price signals,although the juniors in the sector are morenimble. A robust market allows miners to domine plan, determine cutoff grades,miners need to be able to reset their cutoffgrades to remain economic. The speed and1. “Drilling down and polishing up,” The Australian FinancialReviewManagement Pty Limited.2. Thomson Datastream accessed 14 May 2013.AustralianBusiness News, 19 April 2013.Metal Bulletin, 2 May 2013.6. “XE Currency Charts,” www.xe.com, accessed on 8 May 2013.7. “Frightful new realities of mining,” The Australian FinancialReviewManagement Pty Limited.
The business risk report Mining and metals 2013–201420Nathan RoostMining & Metals Advisory Partner,Ernst & Young Australia“High mineral prices concealed the impact of rampant costaddressed.”The cost of not addressingcostsIn 2012 escalating costs had a majorimpact on bottom lines, resulting instock prices. With prices losing scarcitycost despite rewarding this in 2005 to 2008adept at cost control.industry-wide directional change ingrainingindustry ethos. With this comes a newgeneration of leaders who are expected tochampion being at the “bottom of costsper mined tonne and at the upper ranges8Companies that successfully refocus onopportunities when — true to the industry’sreturns.Languishing productivityplagues the industryrace for growth.industry’s input to output ratio. Accordingto the Australian Bureau of Statistics (ABS),Australia’s unadjusted multifactordeclined 33% during 2000 to 2010.10management structures, industrial actiongreater insourcing to gain greater control ofoperations allowing focus on operational(indirect) mine workers from the past10 years8. “Drilling down and polishing up,” The Australian FinancialReviewManagement Pty Limited. boss,” www.miningaustralia.com.au (construction material mining).Labor CapitalAustralia -4.02 -1.41 -1.99US 0.66 -2.25 -1.68Canada -2.21 -0.28 -1.07Average annual growth in productivity (%) during 2000–07Mark CutifaniCEO, Anglo American“The mining industry is decades behindother parts of the economy onIn the mining industry, we’re some20 to 30 years behind other more9Mining labor productivity has declined by roughly 50% since 20014060801001201401601994-951995-961996-971997-981998-991999-002000-012001-022003-042003-032004-052005-062006-072007-082008-092009-102010-112011-12Market sectors (ex. mining) index Mining productivity index
21The business risk report Mining and metals 2013–2014trade-offs in labor negotiationsBetter use of operational data andGreater empowerment of workers tochallenge and redesign processes thatfactors, such as the long lead timestechnology to name but a few. In addition,optimum mix of labor and capital as manyproduction in response to demanduncertainties.and more capital to the challenge toincrease production, rather than looking toexample, with falling copper grades,truck performance from 2006 to 2012, theinputs.11true capital needs and applying fresh“under-trucked”tolerance for dilutionmature minesBetter use of operational data andinteraction and better training andContinued de-bottleneckingRisk transfer to third-party owners ofassetsRebalancing product chains to betterintegrated logisticssolutions across the sectormanagementA renewed focus on continuous processSix SigmaRefocus innovation — fromsupply growth to productivityenhancementmining and metals sector has been focusedsubstitution of capital for labor in responseto a growing skills shortage.With a contemporary need to increaseinputs, as well as doing what we currentlydo better.suppliers, rather than rely onin-house labsincrease speed to marketthan a capability looking for a needData the new fuel forproductivityWi-Fi and wired networks, mine planningmodels and performance reporting.Increasingly, this data is supportingmonitoring, automation, machinetelemetry, proximity detection and remoteblasting.The mining and metals industry does notcollection is generally single purpose.As the industry enters an era of big data,studies and process mapping of old. Forexample, data can also be gathered tobest practices of which can then be11. Ernst & Young research, 2013.
The business risk report Mining and metals 2013–201422The right skill set to maximizenew technologytasks for the rapidly installed technologyallows for the reassessment and retrainingtechnology in the world, but if the peopledo not buy into the technology, if the peopledo not know how to operate the technologyand do not support the technology, thenyou’re setting yourself up for failure.”11Required policy initiativesThe scale and complexity of new capitalfailure and stakeholders misalignment.ownership responsibility to fosterframework for industrial relations and needmicroeconomic reform must address theseOutlookannouncements were rife in 2012 and2013, including industry-wide layoffs, minewill mean some relief in terms of risingcosts, although cost pressures are unlikelyto abate in a hurry. Meanwhile, the presentausterity in the mining and metals industryis said to be laying the groundwork for thenext upturn, calling for balanced cost cutsand controlled growth. Margin protection,costs, and a renewed focus on operationalGoing forward, the industry is expected toadopt a strong operating focus ascommunicating these), the remaininglowest possible cost per tonne of metal sold(exploration, planning, scheduling, drillingblasting, loading and hauling rock). Theupstream processes. How this information11. “The future of automation,” Mining Australia, 11 December 2012.12. “BHP Billiton presentation to the 2013 Bank of AmericaMerril Lynch Global Metals, Mining & Steel Conference,”BHP Billiton, 14 May 2013.Steps mining and metals companies can take to respond to this riskFocus on sustainable cost reduction programssale or leasebackeconomies of scaleReduce indirect workersEnsure greater multi-skillingUse operational data for benchmarking performanceIncrease automationAndrew MackenzieCEO, BHP Billiton“expand margins and increase returns inthe absence of higher prices.”12
23The business risk report Mining and metals 2013–201403(1 in 2012)Resource nationalism10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand accessAs capital expenditure is reined inand mining and metals companiesfocus on managing their costs andincreasing productivity, it is possiblegovernments will retreat fromrampant tax policy changes andpromote initiatives to attract mininginvestment.forms of resource nationalism — mandatedrestriction of exports, and increasing taxesA growing number of countries are eitherimplementing or considering policiesresources to the country. These range fromrather extreme policies in countries such asconsidered approach by jurisdictions suchGhana and Poland.Beneficiation Government ownership Taxes/royalties2008 2009 2010 2011 2012Type of resource nationalism
The business risk report Mining and metals 2013–201424Andrew MillerGlobal Mining & Metals Tax Leader,Ernst & Youngrich countries, and while it continues to be a majorwhere it no longer is the surprise it once was, andcompanies are getting better at managing this risk.”nationalism is out of kilter with mining andprices are promoting a more cautiousapproach to large-scale projects. Withgreater demands from shareholders tocompanies are delaying mining and metalsprojects or canceling them all together.As a result, there are already early signsthat there has been a retreat on some ofthat mining companies pay on mineralsthe mining rules changed.1In Guinea, theby lowering some taxes in order to boostfalling from 35% to 30% and the bauxite taxfrom 0.55% to 0.15% of the internationalmarket price for aluminium.2That said, it is unlikely that resourcelook to companies to fund the shortfall inIt is also often at this point — just before anthe sector.considered measures to increase theirparticipation in mining and metals projects.Mongolia — Legislation was proposed tomineral projects as well as the right tospecify output targets regardless ofmarket demand.3The MongolianTolgoi — it presently has a 34% stake butis excluded from the running of theincreased participation by domesticbusinesses and greater transparency insupplier selection.4Argentinait has struggled to protect a shrinkingtrade surplus despite implementingimport restrictions. Draft laws submittedby the local authorities in 2012 led to the5Burkina Faso — A new mining code will beput before the National Assembly in 2013company in return for payment at themarket rate. This is in addition to theState’s free 10% holding that the currentthe sector.6Bolivia — Mining reforms introduced bytheir current concessions and shared riska majority stake or, in the absence of that,7Democratic Republic of Congo — Theand a bigger stake in projects.8countries are consistent in their desire toexercise this policy aim through stateownership of domestic resources and tostate-owned mining and metals companies.production.in the regulation of mining and metals. Itminerals. The national interest can best behost nation.State-owned mining and metal companiesmanage, thereby potentially reducing thecountry’s return on its natural assets. Suchmismanagement often occurs becausea dynamic world.Mining Weekly, 15 March 2013.Global Insight, 10 April 2013.3. “Mongolia’s mining laws threaten biggest coal project,”MineWeb,matters into its own hands,” Mining.com, 4 February 2013.business climate,” Mining.com6. “Burkina Faso promises new mining in 2013,” Global Insight,Reuters,24 August 2012.ReutersMining Weekly
25The business risk report Mining and metals 2013–2014a long time to pay off, and if commodityprices decline, the timeline can extendand metals projects when there are9This iscommodity prices.For mining and metals companies,necessitate strong stakeholderfor all stakeholders, all of which needs to beIncreasingly, countries are also seeking toproducts as opposed to the raw materials.projects that will ensure there is a greaterdone in Guinea.10South Africa and Indonesia, are also in theprocess of implementing similar mandatoryencourage mining companies to processminerals in country.export regulations passed in 2012 as not allmining companies are ready to build2014 deadline a complete ban on thethat constructing a smelter takes time,money, technology and electricity supplyand is seeking a solution that will make itto build them.11smelters and manufacturing facilities,both of which are often in short supply inthese countriesprocessingsupply chainAs resource nationalism has become moreendemic, mining and metals companiesrapid natural resource policy changes. TheyBecoming politically savvy andfactoring country risk into pricingmodels — The rising participation ofmanaged by companies and priced intomodels. As a result, companies arefactoring country risk into their projectassessments and determining its affecton, amongst other things, capitalBuilding strong relationships withgovernmentteams to negotiate with and educate the12In addition,13Building brand and communicatingeffectively on the positive impacts ofminingcommunication process highlighting thehow their presence in the country cancontributions. In a time of assetimpairments and project deferrals, minersindustry associations to educate thetheir proposed tax policy changes.Increasing the transparency of theirpayments to Governmentas well as taxes such as VAT on purchasesMontreal Gazette10 “Guinea says new code encourages miners to do more thandig,” Reuters News, 10 April 2013.Boardroom,” Ernst & Young, April 2013.13. “Resource nationalism new form of mercantilism,”MiningIndaba.com, 7 February 2013.11 “Indonesia softens stance on unprocessed mineral exportban,” Global Insight, 11 April 2013.
The business risk report Mining and metals 2013–201426and long-term operation of mines withand associated income and payroll taxof a mine.Implementing arm’s-length valuation ofrisks and functions throughsophisticated transfer pricing — Higheraround the world are taking a hard look atdiscussion paper.14For example, inleakage through intercompanytransactions. Mining companies will needto ensure that global supply chains arecarefully planned and fully documented toin producer nations.Steps mining and metals companies can take to respond to this riskinfrastructure in the host country
27The business risk report Mining and metals 2013–2014Social license tooperateIn a volatile operating environment,managing the needs and expectationsof communities, governments,employees and other stakeholderswho provide mining and metalscompanies with their social licenseto operate (SLTO) can be a delicatebalancing act of agendas and issues.In times of increased activism,digitally connected stakeholders andpoliticians who need to respond togeneral consensus, the pressure is on!Increasingly savvystakeholdersconcerns and increasing their scrutiny.For example, air emissions are of particularaccess to real data and often undertaketheir own monitoring using low-cost digitallySocial media is also empoweringstakeholder both en masse and withinsmaller community groups. Instead ofliaising with the designated communityleader (such as the mayor, chief or elder) inthe Web 2.0 era, many more impactedparties need to be included in theconsultation and education process.of their rights and are prepared to defendthem using social media and otherchannels. These factors increase theurgency for companies to respond tocommunity concerns and complaints.communication needs to be more strategic.Communities should be consulted from theidentify and ideally eliminate potentialissues. Cloud Peak Energy recently soughtexploration agreements with the Crow Tribewe see as a long-term partnership with the1Anti-mining agenda incommunitiescommunity groups can be manipulated bypoliticians and other groups with widerpolitical agendas that magnify the challengeof community consent. There is strongas water access or loss of artisanal miningwith existing operations are choosing to runat a loss for a period of time in order topotential high-cost mine closures orsuspensions on local communities.including Latin America and Africa.2012, with mining and metals operationsimpact on human rights, communities andThe majority of the cases are related to the2This includes theUS$4.8 billion Conga project in Peru, whichwas deferred in 2012 due to ongoingopposition from local residents concernedabout potential water pollution.3The Bank of America estimates thatincreasing anti-mining protests in thecountry.4There is potential contagion ofand Argentina.1. “Cloud Peak Energy and the Crow Tribe of Indians SignGlobal Insight, 21 March 2013.3. “Conga delay undermines Peru perception,” Miningweekly,10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access04(6 in 2012)
The business risk report Mining and metals 2013–201428Mathew NelsonServices Leader, Ernst & Young“As the expectations of mining and metalsoperate. It is not a task that has a beginning andan end, rather it is an ongoing relationship thatneeds constant attentions.”The AustralianFinancial Review, 7 March 2013.6. “Think local on new mines, institute says,” The AustralianFinancial Review, 10 April 2013.project,” Reutersbarrick-chile-pascualama-idUSL2N0E51AV20130524, accessedexpansion,” minewebmineweb/content/en/mineweb-fast-news?oid=186177&sn=Detail,accessed 24 May 2013.Unfortunately, bad media and reputationaldamage suffered by one company can,in turn, result in collateral damage for thewhole industry. Companies need to be waryof the potential of bad press and the impactguidelines. They were issued with heftyto an existing dispute with agriculturalinterests seeking to gain greater controlpublicity.5developing world’s concernsWhile the mining and metals sector hasdensely populated countries such as China,to its detriment. No better example existsthan the grassroots call to end theChina experienced in early 2013. Theto announce a 4 billion tonne annual cap onthe burning of coal to curb its circa 20%contribution to Chinese air pollution. Thiscap will impact producers of low-energy,high-sulfur and high-ash coal, resulting inwith higher demand resulting in a pricingpremium.Increased regulatory andjudicial activismThe growing community concern about theimpact of mining and metals operations isleading to increased legislation to protectbetween expectations and existingregulations. In Australia, the RegionalAustralia Institute is proposing that miningcompanies engage with communities to6reporting standards, which include newdisclosure for listed companies. Also, theEuropean Commission is adopting acertain large companies on social andAs if increased legislation and protractedenough, there are increasing instances ofbeen obtained. Recent examples includeBarrick’s Pascua-Lama project in Chile andRio Tinto’s Warkworth/Mount Thorleyproject in Australia.7This highlights howstakeholders are turning to the courts toapply a less technical interpretation ofstyle of action.new resources and, in the states of Goa andKarnataka, are banning iron ore exports.Land access for coal, bauxite and iron oreminers has become more problematic ascompeting land use for cultural,purposes has, to date, found sympathy inthe Indian economy in years to come, theseborders of India.Changing expectationsproviding new threatsGlobal climate change concerns andincreasing regulation mean that fossil fuelresulting in stranded assets and highAustralia’s Climate Institute and Carbon1 Water access2 Competing land use3 Artisanal mining rights4 Water quality5 Community relocation6 Loss of natural environment7
29The business risk report Mining and metals 2013–2014Institute and Carbon Tracker, April 2013.Tracker8reports that Australian coalglobal warming to 2°C. This exposesAustralian producers to reduced demand astraditional coal importers respond tointernational climate change commitmentsIt is the same story for coal producersglobally. In 2012, the International EnergyAgency acknowledged that, in the absenceof carbon capture and storage technology,more than two-thirds of coal, oil and gas2050 if we are to commit to the sametargets.9don’t take into account global climatechange policy and the implications of alow-carbon future. Companies need toconsider how they communicate theirand scenario modeling and identifyopportunities in a low-carbon future.Increasingly, anti-mining protest groups areusing carbon emissions as a social, legalof new coal mines.as a known (Group 1) carcinogen tohumans. Since diesel exhaust now joinssmoking, asbestos and radiation as ana safe working place are far reaching.The mining industry is highly dependent ongeneration. The risk is greatest forunderground operations where theseparation of humans from exhaust will beoperating costs of underground mining.Community support for a project is partlydependent on its economic participationand local employment is an importantelement of that. This has promptedto limit the number and roles of foreignmanagers and mine workers. In establishedmining nations such as Chile, Australia andscarcity premiums in incomes.Mounting community opposition toworkforces on local and regionalcommunities has placed this issue on thepolitical agenda. In Australia, the 2013described it as a cancer in society andrecommended policy changes that wouldmining) more costly, including changing theCommunicating the valueremains a great challenge for companies,responding to this risk. Where mining andcommunities and for broader stakeholders,companies and shareholders. Measuringand resilient in how it does business.connections between societal and economicprogress — which has the power to unleashExamples include increasing the capabilityand capacity of local businesses tomanufacturing operations in the areasand reduce costs in the supply chain,contribute to a more sustainable andresilient local community that shares instakeholders and the company anddemonstrate returns from both a socialBe open about how decisions are made.are trying to implement systems to shareoperations, demonstrating that they notwealthier but also healthier. This relies onworking with communities to create
The business risk report Mining and metals 2013–201430In Western Australia, Cameco Corporation,local indigenous group, the Martu, formoney into indigenous businesses10whilealso increasing the capacity of localsuppliers that can create supply chainemploying indigenous peoples is a morereliable source of skilled labor, reducing theworkers and the associated costs, and thecommunity, while increasing shareholderFrameworks and methodologies are beingaccepted accounting principles (SGAAP).These accounting principles are designedto help manage and understand the social,11Engage early and openly with local communities to understandand address concerns around mining operations and implementstrategies to reduce impactssupplier and employee capability, as well as indigenouscommunitiesEmbed these mitigation strategies in all critical businessprocesses to ensure an integrated approachIntegrate sustainability key performance indicators withUse sustainability outcomes to attract and retain workers whostakeholders to reduce security risks in troubled locationsMeg FrickeSenior Manager, Climate Change andSustainability Services, Ernst & Young Australia“The mining and metals business community’s understanding of the potential of sharedAustralian FinancialReview, 2 February 2012.Steps mining and metals companies can take to respond to this risk
31The business risk report Mining and metals 2013–2014The availability of skilled talentremains one of the key long-termchallenges for the mining andmetals sector. While the slowdownin new investment in the sectormight see some short-term relieffor construction and developmentjobs, longer-term demand for labor isexpected to continue to trend steeplyupwards.A number of those projects are not yet inproduction and still need to be staffed.mining workforce increased by 65%. It didso by bleeding other sectors of skills andtransporting them to remote locations, withan 85% increase in long-distance workers1workers will be attracted back to theindustries they came from.According to BHP Billiton, Australia’sresources sector needs an additional170,000 workers by 2016 to 2017.2Thischallenge is compounded by reports bythe Mining Industry Human ResourcesCouncil’s 2010 National Employerworkforce will be eligible for retirementof 21 years of mining sector experience.Together, this will increase the need forskilled workers to 60,000 to 90,000 by2017.3Many other countries face theThe ability to address the skills shortageundertrained, under-manned andunder-experienced project teams cancope but don’t excel in performance.This looming global skills shortage crisisremains a constraint on the long-termgrowth in the sector. From 2008, miningneed for longer-term solutions to thisseemingly endemic problem. They began toA number of mining and metals companiesprocesses. In addressing the skills shortagechallenge, companies must continue toretain existing skilled workers.1. “Analysis of the long distance commuter workforce acrossAustralia,” Minerals Council of Australia, March 2013.2. “Australian mining giant BHP Billiton estimates that theAustralia Pty Ltd.Essential,” mining.com,answering-the-hr-challenge-why-industry-collaboration-is-essential/, accessed on 10 May 2013.facing the Canadian mining industry,” miningweekly.com,storm-2013-01-28, accessed 30 April 2013.05(2 in 2012)Skills shortage10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access
The business risk report Mining and metals 2013–201432The nature of the risk shiftedin 2012forced to trim their staff numbers due tosectorial and regional with the coal sector,aluminum, steel and uranium sectors allimpacted by suspension of projects orclosure of high-costs mines.The implications of these redundancies forExodus of talent from the sector: laid-offstaff are likely to seek employment inother sectors offering more opportunities.Costindirect costs include training costs fornew hires or higher compensation toreattract and induct talent when theLouise RollandExecutive Director, Advisory,Ernst & Young AustraliaIn cost reduction mode, the industry hasredeploy it to areas of greater need.been left to try and facilitate thisredeployment.The impact of layoffs1. Social license to operateIn a cyclical industry, job security canbecome an issue. Thus, widespread layoffsindustry’s social license to operate,damaging relations and the ability tonegotiate future contracts witha South African-based Anglo Americansubsidiary, announced 14,000 job cuts and13potentially setting2. Brand damageA mismanaged layoff can impact acompany’s brand, not only as an employer,but also as a socially responsible corporatebrand reputation.forecasting and planning processes.Although companies can often do littlea strong ability to forecast and planclear communication, timely coursecorrection and management of risk in anuncertain market.“There has been a short-term easing in the skillsshortage crisis because of project deferralsand cancellations, but it remains a medium tolong-term challenge especially in geology andengineering.”5. “Rössing announces major organisational restructure,” Rioaccessed 1 March 2013.HandelsblattThe West Australianworkers are to go,” Townsville BulletinThe Australian,4 December 2012.10. “Willow Lake Mine in Southern Illinois to be Closed,” Peabodyoperations through market cycles,” Tata Steel company website,12. “Arch Coal Responds to Thermal Coal Market Weakness byThe GuardianCompany name Region Jobs impactedRio Tinto5 Rossing uranium mine in Namibia 276ThyssenKrupp6 Across Europe 2,000BHP Billiton7 Olympic Dam, Australia ~100Xstrata8 Collinsville coal mine, Australia ~100BHP Billiton and Rio Tinto JV9 Arizona, US 400Peabody10 Willow Lake Mine, US 400Tata Steel11 UK 900Arch Coal12 Virginia and West Virginia 750Total Approx 4,900Job cuts
33The business risk report Mining and metals 2013–2014mining and metal sector is replaced eachyear. This costs the local industry aroundA$140 million per annum.14According toAustralian Mines and Metals Association,the resources industry has the highest15Mitigating the long-term riska major long-term industry challenge.framework. Solutions include technologymodern workforce and tapping intodifferent sources of labor. These options aresupporting the local economy.As the mining and metals businessdifferent skill sets within the sector.3. Loss of investmentSkills shortages not only increase the directcost of labor but also the indirect costs,assess the indirect costs at nearly doubledirect costs. Mining and metals companiescost cutting may be short term as they areat risk of being eroded by increased costs,both direct and indirect, when the sectorreturns to growth.4. Increased turnoverThe industry is facing increased employeestakeholder engagement, and strategicthinking to meet these challenges. This willconfront the makeup of the board, theC-suite and middle management. It willsector and accelerate the gender balanceon a needs basis.working to adopt automation technologiesacross the industry. Rio Tinto’s Mine of theFuture program is expected to bringautomation to the company’s mine sites.16BHP Billiton is also implementing aprogram, Next Generation Mining, whichincludes integrated remote operatingcenters, autonomous haulage, autonomousmodeling ore bodies.17Automation doessuch as skills shortages, deeper ore bodies,increased safety regulations and a carbon-constrained future.Promoting automation may attract newtalent to the industry and change thetechnical roles necessary to design,implement and maintain these newsystems. Increasing automation may alsoand instead manage their jobsfrom a remote location.Tapping theuntappedRetainingmodern talentBetter trainingof existing talentFlexibility andmobility of theworkforceAdopting newtechnologyAddressingskills shortage1 April 2013.17. “BHP Billiton Could Slash Work Force with Automated Mining,”DesignBuildSource.com.au, 15 March 2013.Financial Review, 17 May 2012.Papers/20130227AMMA%20Research%20Paper%20-%20
The business risk report Mining and metals 2013–201434The traditional model, wherein a workerjoins the sector after completing anundergraduate program and stays in thehistorical one.People are more likely to change jobs andmetals companies can facilitate thesechanges by opening up differentexperiences for their staff and therebymaintain their talent pool. BHP BillitonMitsubishi Alliance (BMA) is doing just this,broad-based training applicable across all itsoperations. It has awarded a US$21 millioncontract to the Australian Institute ofManagement (AIM) to offer around 140training courses focused on businessand project management.183. Tapping into new skill sourcesWomen and local workers remain a sourceAccess to a latent talent pool: Tata Steeltraining to enable employability in the sixmillion metric ton steel plant.19Likewise,enterprise migration agreement.20Corporate social responsibilitycredibility: while employing thecompanies access to as large a talentis recruiting indigenous candidates forhaul truck operator roles at its Yandi,Mining Area C and Eastern Ridge minesites in the Pilbara, Australia, and RioTinto is the largest indigenous employerin Australia.214. Increasing mobility of potentialworkersRapid growth in the sector has seen anincrease in projects in remote locations,with high employment in the sector allowingallow workers to combine big-city lifestylesdistant destinations in smaller planes.In addition, little is known about the impactThere is a long-term mental health impactextended periods of separation fromfamilies and reduced social andcommunity interaction.There is an economic impact on housingas an increase in demand for housingpushes up prices and affects affordability.It can also impact local businesses andthe local economy if mining companiessuppliers outside the local mining basedcommunities.The local social structure is impacted aslocal demographics. It also increases theboth encourage greater mobility and attractworkers to reside in remote areas.Risks attached to solutionsrisks associated with the solutions theyadopt to address the skills shortage. Forcountries such as China and India and inengaged coal miners from China to work intheir underground mine.22While thiscompany, large-scale migration in a shortperiod of time can create settlement issuesand impact the local population. The localof HD Mining in federal court that itemployed Chinese workers on temporaryCanadian workforce.23institute,” The Courier-Mailset up by Tata Steel at Kalinganagar,” Orissa Diary,Returning to China,” HD Mining company website,project-temporary-foreign-workers-returning-to-china,20. “BHP, Rio hiring local for now,” The Australian, 29 May 2012,21. “Paid skills training for Indigenous candidates,”Central Midlands Advocate
35The business risk report Mining and metals 2013–2014Source talent from aligned sectors and a broader demographicInitiate programs that encourage semi-skilled and retiredworkers to upskill or re-enter the workforceCreate employment offers that better balance remunerationImplement early labor scheduling and sourcing within mineplanningthese gapsOutlookIn the short-term mining and metalsproposition to attract and retainstaff — namely compensation and non-downturn eases the skills shortage pressurechallenges posed by the issue. Skillsshortage is expected to remain one of thebiggest risks facing the mining and metalsindustry. Such an acute shortage of skillscan be somewhat mitigated if the sector ismobility of its workforce.Steps companies can take to respond to this risk
The business risk report Mining and metals 2013–201436Price and currencyvolatility10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access06(7 in 2012)Across the mining and metals sector,there is renewed emphasis onperformance, meeting targets andresponding to shareholder needs,with the sentiment being one of long-focusing on protecting margins andcontaining soaring operating costsrather than boosting output. Costin large part by market risks, includingcommodity price volatility, interestand exchange rates, and equity risk.1In the December 2012 reported results ofcomprised 79% of the fall in period-on-period earnings. Producer currencyoften depreciate with falling prices.this depreciation from occurring in mostproducer nations. As such, the currencyonly by 2%. This loss of a natural hedge hasLower commodity prices and the higherto curb costs to maintain margins. In thepractical, targeted higher-grade ore insteadof lower-grade material, which becamemore economic to mine as gold pricesgold ore grades as the gold price has risen,but if gold prices remain low, the processlow-grade ore processed, with gold gradesincreasing and cash costs being reduced.of this scenario is that gold mines with theactually produce more gold when pricesare lower.2Is hedging a sanctuary fromvolatility?The drastic fall in gold prices duringApril 2013 increased pressure to hedgenew production forwards. In The lost artof hedging,3Ernst & Young found that aas long as it was entered into when priceswere higher. Companies should be cautiousabout the herd mentality to hedge withfalling prices and close out hedge booksduring times of rising prices. Ideally,the time to hedge is when metal prices arenear their peak. A good indicator is tohedging is more likely to produce gainsrather than losses. The recent drop in thegold price demonstrated how the speedof price changes challenges in-house riskmanagement systems to respond ina timely fashion.strength to absorb the downward price risk,mid-tiers and juniors entering productionmight not. This means smaller producerslenders to enter new hedge contracts.4With rising costs being a sector-wideproblem, we expect to see more companiesusing short-term hedging to lock in costs,commodity price hedging.December 2012 — Fall in earningsPrice FX Other19%79%2%global report,” Ernst & Young, 2013. Reuters, 24 April 2013.3. “The lost art of hedging,” Ernst & Young, April 2011.Mineweb,
37The business risk report Mining and metals 2013–2014Volatility and riskprice signals for increasing supply.But it has also created the conditions forsupply, causing prices to crash and therebycapital strike. This will be accentuated asmany high-cost, low-grade mines, whoseof years in the face of low prices. Until thenew normal.Mining and metals companies must considerthe potential price and currency outcomesexperienced in recent years, many potentialscenarios could exist. Examining those asthe likelihood of each. The modern minemanager must consider these scenarios in aprobabilities of each in a deterministicfashion. Best practice in the current climatehas managers measuring uncertainties,probabilities and the impact decisions maythe appropriate interactions between risks.Many mining and metals companies do thisbut stop there. They don’t go on to assignprobabilities to these risks. Much of theprice and currency uncertainty can be seenempirically with how the market is pricinguncertainty. Modern computing power andmodels enable not just the one scenario tobe prepared, but multiple scenarios usingnumerical methods, such as Monte Carlosimulation. The risk or the uncertaintyoutcomes. It also focuses attention on howmuch the mining and metals companiesmay be willing to pay, by way of cost ofIn a period of falling prices it is important toremember that there are other options tochallenge for managers is to identify thesepotential price and currency uncertainties.Using the right tools to tamevolatilityin the face of changing prices and currencytemptation of many is to increase thespikes and limiting the exposure to priceUndertaking no new actionSuspending mining and process stockpilesReducing shifts and hence productionAbandoning production and selling eitherthe project or hybrids thereofnot account for how these actions affectBest practice responses to price andcompanies with a guide for the possibleUnfamiliarity with these tools and thesupporting theoretical basis by decision-makers is the biggest obstacle to theirtechnical language. For those managersfrustrating, alternate price decks and
The business risk report Mining and metals 2013–201438Jay PatelMining & Metals Transactions Partner,Ernst & Young, Canada“As supply begins to catch demand, we expect a periodcurrencies. The knee-jerk reaction is to start hedgingthe short term will be a focus for the miners.”Being nimble with cutoffgrades and mine sequencingcutoff grades are often establishedthe most economic grade to be mined andincreases.Between 2009 and 2012, sustained priceincreases encouraged mine operators tothe mill. Changing the residence time of orescenarios for mine and mill grade cutofffrom a mine during a period of pricemine production scheduling has occurred.such as price. Some of the features includepath through the deposit and nesting ofinterim pits culminating in the ultimate pit.of coststypically most fatalistic in the face of pricebetter practice for managers to buildproductionthe hour modelVarying stockpile managementUndertaking campaign rehabilitationusing contractorsMany of these options will challenge miningoften trumps the desire for total control andhighlights the importance of partneringrelationships with key suppliers of theseChallenging notions of scaleWhen production is no longer beingIs the dilution created by large-scaleDuring lower prices, is the mine better offThese may all result in lower production,to enable fast action before the majorityfollow suit.
39The business risk report Mining and metals 2013–2014changes to mine planning both internally and externallymanagement plans linked with expected returnscorporate risk appetiteChoose the right tools to identify and assess options to react toprice riskPrepare for a future hedging program when prices once againincrease, while managing short-term price riskOutlookDuring 2013 and 2014, mining and metals companies will bepreoccupied with reacting to the downside risk of price andmetals companies to commence a hedging program that can betterSteps mining and metals companies can take to respond to this risk
The business risk report Mining and metals 2013–201440Capital projectexecution riskIn 2012, there were fewer capitalproject announcements againsta backdrop of volatile commoditypressure from shareholdersdemanding short-term cash returnsbe maximized. Leaders of the majormining and metals companies haveresponded with a capital strike, withthe number of new capital projectsannounced in 2012 declining by21%,1while the value of new projectsdeclined by 57%.2The effect of this decline will be felt in thewhen the newly announced changes to thecapital projects enter construction phase.construction capabilities, such as skilleddemand and supply align.Drivers of capital projectexecution riskThe contributing factors to capital projectexecution risks are largely unchanged andTighter constraints on capitalChallenges in project economicforecastingGlobal human capital constraintsPoor cost and schedule controlunder-performancePoor program and project contractingstrategyLack of access to strategic infrastructureFinancial and commercialmismanagementLegal and regulatory compliancestakeholder managementBroader usage of Engineering,Procurement and ConstructionManagement (EPCM) and tendency awayfrom in-house program managementThe drivers of a changed riskcapital project execution risk has increasedas a risk that needs to be addressed andplus recognition of the project impacts ifbudgets and timelines are out of sync withstakeholder demands. Poor management ofcapital project risk can not only compromisethe schedule and cost budgets, but also10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access07(5 in 2012)5%57%0501000501001502002008 2009 2010 2011 2012%Growth-21%-37%-10%-50NumberofnewprojectsannouncedNumber of new global mining projects announced40%88%83%0501000501001502008 2009 2010 2011 2012%Growth-60% -57% -50-100Valueofnewprojectsinvestment(US$b)Value of new global mining projects’ investmentas announcements made by the end of 2012 are registered inRaw Materials Database by 2013.
41The business risk report Mining and metals 2013–2014of decisions years agocapital projects and/or impairment write-a backdrop of economic uncertainty andunstable demand growth. While externalfactors played a large role, it begs theto begin with and are the project gatingprojects through their life cycle?2. Large mining and metal projectsdelayed for rationalizing andreplanningmining and metals companies to delay largeBHP Billiton decided to hold and redesignProject.3Peabody placed the expansion of itsMetropolitan metallurgical coal mineand Wambo open-pit thermal coal mineon hold.4Despite the reassessment of projects,mining and metals projects, albeit with abecomes deareraccentuates the need for careful planningmanagement, considered project selectionthe minor mining companies are struggling4. Cost overruns and delays continueThe resource sector continues to witnessBarrick Gold’s Pascua-Lama Gold project’scost estimate increased US$0.5 billion induring 2012.5its estimates for completing its MinasRio project in 2H 2012 at a cost ofUS$8.8 billion.6Both projects are behindscrutiny of project execution.There is also a heightened awareness thatof a project’s success, since theimplementation of the project plan — onschedule and, taken together, theseunderpin an accurate estimate. Late in thestart the commercial production as plannedMining Weeklyarticle/outer-harbour-project-not-best-option-right-now-bhp-2012-08-24, accessed on 3 April 2013.4. “Peabody Energy slashes growth strategy,” The Australian,mining-energy/peabody-energy-slashes-growth-strategy/story-e6frg9e6-1226467682581, accessed 4 April 2013.5. “Costs rise again for Barrick’s Andes mine,” The Globe and Mail,report-on-business/industry-news/energy-and-resources/costs-rise-again-for-barricks-andes-mine/article4809243/,accessed on 3 April 2013.$4 billion impairment,” Press Release Anglo American website,releases/2013pr/2013-01-29, accessed on 3 April 2013.
The business risk report Mining and metals 2013–201442How mining and metalcompanies are responding tochallenges associated withcapital project executionMitigating risk is about predicting thefuture, and a risk management process isonly as good as the people producing it.While there is an increased focus onprudent project selection and planning,associated with capital project execution.1. Increase the focus on managingstrategic risks by senior managementThere has been a marked increase in themanagement in portfolio management,decisions. Mining and metals companies aremaking a concerted effort to staff seniorcapital project management experience andcredentials. For instance, BHP Billiton’shas a strong background in the resourcesmining conglomerates, which is expected toreporting structure is key for a project teaminformed about capital project execution.process is also essential to enable seniormothball projects when they becomeuneconomic or misaligned to the company’sstrategy. This would help seniormanagement to pre-empt strategic risk2. Improve capex predictabilitythe projects in their portfolio. Mining andmetals companies are increasingly usingassessment methods to measure risks andlife of the project, and not just at thebusiness case stage.on ensuring rigor in the underlying businessplan during implementation.3. Become an intelligent owner65% of mega projects fail7— mining andmetals companies must decide what theirand/or ongoing production. Many of thethis point for some years now.owner in the project space and decide howthey balance in-house capacity andcapability with external assistance throughEPCMs. The focus needs to shift fromshort-term, tactical management ofcontractor relationships — whereon the project to date — to long-termstrategic relationships where upskilling ofboth the owner and contractor results inin-house project management capabilityand capacity. There is an increased focus onbuilding exact and measurable performancetargets and reporting mechanisms tostructurecan be outsourced. The owner needs toretain responsibility and accountability ofby senior management and independenttransparency and proper accountability,both successes and failuresTransparency in communication can bewithin mining and metals companies so thatnot only successes are welcome, but failuresare also openly discussed and accepted.This will allow them to be corrected andlearned from. Many of the mega capitalprojects that are now being canceled andrisks been escalated sooner, with greaterprobabilities.8Claus JensenAdvisory Partner,Ernst & Young Australia“There has been a growing trend in the cancellation ofinstead there has been a shift from scarce resources toscarce capital.”9 May 2013.
43The business risk report Mining and metals 2013–20146. Contingency planning — what isyour plan B?cycle to assess progress against plan andand prompt remedial measures. They alsocontingency planning including settingaside resources and funds. Taking the timeis key to countering unforeseen and7. Asset portfolio review andmanagementconditions, mining and metals companiesnon-core assets — including projects underslim down the company’s asset portfolioreturns. Mining and metals companies areportfolio, program and project management8. Understand the capital projectorganization network and itsperformance could help unlockMega capital projects are complex — theparticipants to manage the risk and meetchallenge. Ernst & Young research hasinside and outside an enterprise. It isconnects, how it communicates, howdecisions.Understanding the nature of theserelationships and costs) and hencethere is a missed opportunity.9. Standardize design andconstructionsolutions to standard problems. The key toengineering designs and practices.comply with a company’s design standardsalready designed, tested and implementedin another project.OutlookRecent research undertaken byErnst & Young indicates that while therecapital project execution within the miningand metals sector, it has not deteriorated. Inundertaken. They also need to be managedconstruction approach — are now becomingwidely used terms within capital projects inthe mining and metals sector. It is thereforeemphasis be placed on understanding theWhile the time of project failures is certainlynot behind us, many large and spectacularof major mining and metals companies.pressure from shareholders, it stands toreason that future mega projects beoptions for reassessment throughout theproject life cycle.Rigorous portfolio management and greater scrutiny aroundprocedures and databasesa clear line of sight between project, portfolio and strategic risktactics that address all potential project threatsEnsure project and supply chain performance is monitored andmanaged by aligning owner and contractor teams alike throughSteps mining companies are taking to respond to this risk
The business risk report Mining and metals 2013–20144410. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand accessThe past year has seen a dip in thevalue created by many mining andmetals companies in the face of lowercommodity prices, higher costs,increased risk and capital projectstakeholders of mining and metalsprojects have shrunk, there is a lagin the readjustment of theirexpectations and most are stilldemanding a greater share.created by mining were both increasing andproducers were struggling to balance thegreater urgency to respond to stakeholdercompanies are still adjusting to sharing theThe lag occurs as the signals of change inthe return to the stakeholder do not occursimultaneously with the price signalscompanies. For example, lower coal pricesdo not cause coal workers or their unionsto moderate wage demands until a numberof high-costs mines begin to close andthe number of unemployed mine workersincreases. Miners increase this lagby delaying the suspension of cashThe following table sets out the time it takesfrom when a signal occurs to when areduction in demand is seen.08(9 in 2012)Stakeholders Signals Timing after a fall in pricesGovernmentEmployeesCommunitiesShareholdersSuppliersmanage stakeholder expectations, both ofwhich will make them more sustainable incommunities in which the operations are
45The business risk report Mining and metals 2013–2014Understanding and managingstakeholdersStakeholder demands and needs differdepending on the group and theirThese groups typically includeemployees and suppliers. Understandingtheir differences, and managing theseaccordingly, will secure the best outcomefor all.1. Governmentsthey seek to secure greater domesticparticipation in the wealth of the super-sought to increase royalties and taxes butinclude increased participation throughdomestic participation in projects. Examplesare South Africa’s yet-to-be implementedon unprocessed ore in Indonesia andin the resource nationalism risk section ofcreating policy by referring to yesterdayrather than anticipating tomorrow.Unfortunately, resources policy is targetingmetals sector has not enjoyed for a numberof years.2. Communitiesmining and metals project prosper more.Because of this, communities feel they areamongst communities, e.g., in Peru andChile. Communities need to clearly see a fullincreased employment opportunities andexpanded business opportunities. Many ofto the communities at the time ofconsultation.In Australia, community frustration hasrights to extract coal seam methane, andbecause farmers are unable to unlock intoare turning to other mechanisms such asamicably negotiated a large number ofagreements with landholders without goingto court, which has historically been thecourse of action.1020,00040,00060,00080,000100,000120,000050,000100,000150,000200,000250,000300,0002008 2009 2010 2011 2012Totalspend$mcapexandpaymentstoshareholdersTotalrevenue$mRevenue Capex Payments to stakeholdersInvestment and pricing boom peaked1. “CSG sector signs deal a day with farmers,” The Australian,
The business risk report Mining and metals 2013–2014463. Shareholdersbecome more critical of the performance ofmanagement and boards, with the effect onA key focus of this demand is the greatercash returns to shareholders is creating ancash distributions. Not only are timehealthy for the sustainability of the sector.This has the potential to limit longer-termgrowth for both a company and the sectoris a decades-long commitment. Companiesneed to turn this around through clearercommunication with shareholders about theimportance of a long-term growth strategythis with more rigorous decision-makingpotential to make industrial relations apolitical issue. This was seen at its extremein August 2012 at the Marikana platinummine in South Africa when 34 strikingLonmin mineworkers were shot dead and2This highlighted the need for directcommunication channels with workers.While workers may aspire to higher realwages, the dialogue needs to be aboutjustify such increases. Prior to the super-cycle, this was a regular feature of the laborbargaining process.5. Suppliersstarted working with suppliers. This is oneof the few stakeholder groups beinghandled well. The sector’s response toand has included renegotiating supplyagreements. With the renegotiatedmargins to retain a relationship. This hasallowed the relationship focus to switchfrom short-term outcomes to exploitscarcity to longer-term strategies.OutlookWhile stakeholder demands will naturallythose mining and metals companies thatcan best communicate with theirstakeholders to bring that rebalancingthat the next reset does not sow the seedsof stakeholder discontent for the nextSteps mining and metals companies can take to respond to this riskfrom a mine or a facilityMike ElliottGlobal Mining & Metals Leader,Ernst & Young“We are now seeing increased demandfrom most stakeholders for a larger sliceof a shrinking pie.”2. “The unexamined massacre of the Marikana miners,”The Guardiancommentisfree/2013/mar/21/marikina-miners-south-african-protest, accessed 10 May 2013.
47The business risk report Mining and metals 2013–2014economies continues to put pressureon mining and metals companiesto increase supply through thedevelopment of new or existingmineral deposits. Increasingly, newdeposits are found in the so-calledfrontier countries where developmentis challenged through the lack ofinfrastructure.Infrastructure for transport, water andallocated to a mining and metalsfrom around 40% in the late 1990s.1this increase is largely attributable to theincreasing remoteness of many newdeposits and the resultant scale andbring the resource to market. For example,to supply fuels, an airstrip for workerseasonal access to supply fuels. Theseneeds are in addition to the standard mineinfrastructure, which included eight majorbuildings and an electricity generationplant.2Increasing regulation in the form of permita project. For example, Rio Tinto had tocould not economically export coal out ofthe region due to the need for substantial3Need to ramp upinfrastructure — public makingway for privatecompounded by the current economicfunding. This is a perfect storm of highcosts and capital constraints resulting in afund all of the mining infrastructure needs.Weak budgetary positions has meant thatwilling and able to fund infrastructure andthe funding, design and construction of thenecessary means to support the hugeconstruct two railway lines and one port toaround 10 times its national budget.4places third-party capital at the forefront.Potential capital sources include bothin some jurisdictions (Australia, Canada),looking to take long-term ownershippositions in multi-user infrastructure assets.genuine exposures and appetite of the09(3 in 2012)Infrastructure accessMining Magazine,28 August 2012.2. “The future of mining in Canada’s north,” The conference boardBloomberg, 20 February 2013.International Finance Corporation, PDAC Conference 2013.10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access“In our experience, it is not so muchthat the risk allocation is notappropriately structured to supportrisks, expansion rights, and openaccess issues all need to be carefullystructured and allocated.”Neal JohnstonInfrastructure Advisory,Ernst & YoungIn addition, the cautious lending approachof banks and the weaker balance sheets ofmany miners mean that they are not alwaysprepared to lend into infrastructure. Theintroduction of Basel III norms in the comingdebt for long-term projects.
The business risk report Mining and metals 2013–201448Mark WhitePartner, Mining & MetalsErnst & Young Australia“Access to infrastructure is a fundamental partof doing business in any market, and while thechallenges remain more or less the same, thestrategies as follows.1. Majors — selective in their capitalallocationshareholder pressure, are allocating capitalto projects where the margins are highest.5cutbacks. For example, Anglo Americancut its 2012 capital expenditure byUS$1.2 billion,6Teck Resources deferredaround US$1.5 billion in capital spending7and Fortescue Metals cut its 2013 capitalexpenditure guidance from A$6.2 billion toA$4.6 billion.8BHP Billiton has deferred itsTinto has focused on cost reduction and92. Juniors — increasing collaborationare either collaborating with each other orlarger off-take customers to eliminate theproject risks and come to a fundingappear to be collaborating and are using adeposits on the continent. For example, theSenegal, Gambia, Mali, Nigera and Nigeria)to exploit iron ore, aluminum, uranium, oiland natural gas, tin, and phosphates.103. All organizations — selling stakes ininfrastructure assetsof infrastructure assets. Fortescue MetalsGroup, which originally owned and fundedport and rail assets in Pilbara, has offered tosell stakes in the asset to lower its debt and11Lastyear’s decline in iron ore prices has causedcompanies to reassess their asset base.Similarly, GVK Group recently sold a 51%interest in Hancock Coal Infrastructure toinfrastructure in the Galilee Basin.12infrastructure. In an ideal scenario theywould prefer single-user systems thatinfrastructure, such as rail and portcapacity, synchronously and moresolution, asset owners and miners mayrespond differently to emerging pricesignals. The infrastructure operator earnsregulated returns and may not be asDespite this, in the current operatinginfrastructure appears to be a moreGovernment participation —supporter not investorDespite their inability to fund wholecompanies hesitant to fund infrastructurewhen there are no guarantees aboutcompeting facilities being established inclose proximity. In frontier markets, there isexpropriate or take control of theahead of countries such as India andIndonesia. Policy certainty in terms oflonger-term projects.some long-term assets. Third-partyto the underlying mine life. While this isentirely appropriate, it does not take intoconsideration either the potential for futureuse of the assets by other parties or later5. “Interim results, Half year ended 31 December 2012,”BHP Billiton, 20 February 2013.6. “Anglo cuts $1.5bn capex, promises $200m platinumcut by year-end,” Mining Weekly,Mining Weekly8. “Fortescue cuts A$1.6bn from capex, curtails expansions,”Mining Weekly, 4 September 2012.Reuters, 29 April 2013.202011.docx, accessed on 30 April 2013.11. “Fortescue to offer infrastructure stake,” Australian FinancialReview, 17 December 2012.port project,” Miningweekly.com, 11 March 2013.
49The business risk report Mining and metals 2013–2014mine expansion. With its longer-termbeyond the original mine life — this will pushproject economics.Mining and metals companies areresponding by assuming a greater role into fund infrastructure. In addition, they areearlier stage.Mining and metals companies areincreasingly collaborating with non-infrastructure and projects.13Suchbacking. They seek off-take agreements andInthese situations, mining and metalssurrender control in exchange for otherwisescarce funding.Funding from these emerging marketperiod of time, with funding assistance fromemerging markets now comparable in scalein this regard and is using the Resource forprojects. Under this model, loan repaymentis made in exchange for natural resources.This model is being used widely in Africagreater than US$10 billion per annumprojected.14There are potential controlsource that should be explored.Institutional investorsemerged as other sources of infrastructurefunding. These funds are interested inlong-term stable returns and preferpartnership (PPP) model is also beingin the country being a case in point.15Outlookshareholders’ desire for short-term gainsand restricted capital spending, with theneed to maintain a healthy pipeline ofprojects in the long term. The challengetherefore is to be ready with projects whenincreased coordination and collaborationand be willing to share control of theinfrastructure.Steps mining and metals companies can take to respond to this riskUnderstand the return on all capital expenditure, includingincluding off-takeof take-or-pay commitmentsrisks of all parties13. “Chinese infrastructure giant eyeing Canadian gold,”Mineweb, 15 February 2013.from Bloomberg Industries,” minesandmoney.com,12 March 2013.BusinessStandard, 8 March 2013.
The business risk report Mining and metals 2013–201450Shale gas for coal substitutionThe transformational effect that shale gashas had on the outlook for the US energymarket has been unprecedented. Theincrease in US gas production, togetherwith the associated fall in gas prices, haslarge-scale coal-to-gas switching. In 2012,coal’s share of power generation stood ataround a third,1or 40%, and natural gasaccounted for approximately 30%. This is instark contrast to 10 years ago when naturalgas made up just 18% of US electricityproduction, compared with 50% for coal.2or organizations where onecommodity dominates the productcredible and looming threat, especiallywhen the commodity’s recent pricehas been high or there is a regulatoryWhile substitution affects somecommodities more than others, there areit could cause a structural shift in consumerRegulatory pushsupply of commodity or so calledsubstitution of palladium for platinumThreat of substitution is one that canunexpectedly build momentum, should thesubstitution that has occurred in NorthAmerica. Not only has it impacted thismarket, but it is changing the way thisindustry group is operating.Credit Suisse, 13 December 2012.Wall Street Journal,Ernst & Young, 2013.4. Coal Unit Shutdowns — current as of 2 May 2013,American Coalition for Clean Coal Electricity,www.americaspower.org, accessed 6 May 2013.US$1US$2US$3US$4US$5US$6US$7Q12010Q22010Q32010Q42010Q12011Q22011Q32011Q42011Q12012Q22012Q32012Q42012Q12013Q22013US$permillionBTUsNat gas-spot Coal-spot Coal-heat rate/transport adjustedCompetitive fuel prices: 2010–13 (weekly averages)10Threat of substitution10. Threat of substitutes9. Infrastructure access8. Sharing the bene ts7. Capital project execution6. Price and currency volatility5. Skills shortage4. Social license to operate3. Resources nationalism2. Margin protection andproductivity improvement1.Capital allocationand access(new)Furthermore, the International EnergyAgency has projected that the US is set to2035.3This will exacerbate this trend asand low natural gas prices will see furtherlarge-scale substitution of thermal coal forMercury and Air Toxics Standards ruleupdated on 28 March 2013) are justfurther encouragement for power andutility companies to substitute naturalgas for coal.4
51The business risk report Mining and metals 2013–2014Forbes, 13 March 2013.Mark Thurber, Associate Director of the Program on Energy andThe National Bureau of Asian Research, 21 March 2013.FT.com,3 February 2013.9. As at 9 April 2013.1210Historic PlannedNumber of unitsCapacity (gigawatts)864202005 2007 2009 2011 2013 2015607050403020100The drop in coal demand has seen theclosure of more than 50 mines in the USout of just thermal coal into metallurgicalConsol Energy is reducing its plannedcapital expenditure by about 11.5%to between US$1.29 billion andUS$1.5 billion, with between US$835to US$935 million earmarked for theexpansion of the company’s natural gasoperations.5Georgia Power, a subsidiary of SouthernCompany, has announced plans to retiregeneration, shedding 15 coal and oilmix consisted of 70% coal, which hassince dropped to 47%.6Duke Energy plans to shutter 6,800megawatts of coal-based electricity by2015. It will spend US$9 billion tooperational later in 2013.6marketsThe shale gas boom in the US is beginningsupply, and it dominates the US marketfor steam coal. But the decliningcoal looking for more robust markets suchas China and India. If port and railAsia continues to grow, PRB exports to Asiacould surpass those of South Africa but willstill remain shy of export totals fromIndonesia and Australia.7US coal has increasingly found its way intoEuropean markets, where it has displacedpower stations. This has seen utilitiesincrease their use of coal, despite EUpolluting fossil fuels in the energy mix.policy calls for a 20% reduction in carbona growing role for solar, wind and biomassin electricity generation.8of material natural gas export capacity,natural gas pricing in North America hasbecome disconnected from other regionsof the world. Henry Hub prices now standaround US$4.08 per million metric Britishthermal unit (MMBtu), far lower than inEurope or Asia.9