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Two high-profile groups believe the major challenges that miners will face in the coming year come down to one word: costs.
The mining industry is shifting gears in an attempt to deal with new challenges in today’s economy, according to a survey released last week by Ventyx, a leading supplier of information management solutions to the resource industry.
One of the biggest changes seen in the current survey as compared to previous years is the focus mine managers are giving to growing capital expenditures. Of the 374 mining companies surveyed, 25 percent said that managing capital projects was the top challenge they faced over the past year.
In fact, capital costs were the second most important concern across the industry, just slightly behind workforce safety, the number one response. Ventyx notes that emphasis on capital costs has increased “significantly” over past surveys.
Echoing this sentiment, a recent survey by Deloitte identifies cost pressure as the number one challenge facing producers, with margins being squeezed by rising prices for inputs, including equipment, raw materials and labor. Deloitte points out that production costs for copper, aluminum and nickel have reached or exceeded LME prices for those metals. The cost of building new mines has also gone up due to rising labor and materials prices, but there has not been a matching lift in reserves and ore grades.
Input costs still running high
Recent data from the US Bureau of Labor Statistics for the past year shows that miners do indeed have cause to be concerned about costs.
Costs for several input products critical to the mining industry remained at elevated levels in 2012. Labor costs — one of the factors most frequently cited as responsible for cost inflation at mining projects — for the American metal mining industry reached record highs in the second half of the past year, with earnings for mine workers standing some 60 percent higher than in 2002.
Labor cost inflation for metal mining companies has been particularly intense compared to other sectors, such as coal mining. US coal miners saw their earnings fall by the largest amount in 10 years during 2012. As of December, coal labor earnings were down 10.5 percent from the 10-year high they hit in June 2011.
Costs for US diesel fuel — an input that can represent up to one-third of overall costs for large open-pit mining operations — also rose relentlessly in 2012, hitting a record yearly average nearly 3 percent higher than 2011.
The Deloitte study cites figures showing a similar pattern of cost escalation outside of America. For example, in the Australian mining sector, labor and fuel have been the fastest-growing mining input costs since 1996.
The only potential relief for mining input costs came in iron and steel prices. Miners buying steel for capital project construction in the US paid an average of 5 percent less in 2012 as compared to 2011. Overall prices, however, still stand at elevated levels, over 110 percent higher than in 2002.
Quality, not quantity
While miners have typically looked to production volumes to measure whether new capital projects can be delivered, the new cost environment is forcing companies to take a hard look at every project’s return on investment — even those with high mill throughputs. Deloitte notes that over the last few months, “quality [has] trump[ed] quantity,” and that has resulted in a deceleration of capital projects.
“Mining companies can no longer lay claim to a deep portfolio of expansion projects when only a percentage of them is viable,” states the report. “Instead, companies must narrow the focus to those projects capable of delivering a demonstrable return on capital.”
Energy and water shortages are exacerbating cost inflation, pressing mining companies to increase their investments in infrastructure. An example is Chile, where it’s estimated that the country needs to double its energy capacity over the next decade in order to have cheap, reliable power to mine its vast copper reserves.
More flexible mining
Managing projects beyond the initial construction phase has also become a major concern for miners, with a full 40 percent of respondents to the Ventyx survey reporting that their biggest operational challenge is adjusting mining operations in response to changes in the commodities market.
Fine-tuning of project dynamics is also a way for miners to address cost issues. Where project assessments previously tended to focus on large, global resources — driven by a desire to show growing in-ground reserves and possibilities for expansive production increases — developers are now drilling down to the highest-value areas within specific projects and are looking at maximizing value through staged development.
Junior developers too are repackaging their projects in an attempt to balance costs and growth — trying to match the mindset of larger companies that might be potential acquirers.
Keegan Resources (TSX:KGN,NYSE:KGN) recently released a revised development plan for its Esaase gold project in Ghana, noting that it is eyeing a lower throughput plant design with a much-reduced capital cost. The company also reviewed options for using selective mining methods to capture higher-grade ore earlier in mine life, rather than the all-in bulk mining originally contemplated.
Earlier in 2012, Exeter Resources (TSX:XRC,AMEX:XRA) released and compared results for two separate prefeasibility studies detailing different development scenarios for the company’s Caspiche gold-copper project in Chile. One study looked at stand-alone mining of the upper oxide-gold layer of the deposit — at lower costs — while the second considered a more capital-intensive development of the entire mineralized body.
M&A to increase
Another interesting trend outlined in the Deloitte report is the move towards more mergers and acquisitions in a tight financing environment.
While mining M&A slowed down significantly in the last half of 2012 — a topic covered extensively by Resource Investing News — Deloitte points out that more deals could be on the way this year as corporations look at “non-traditional forms of financing” to raise capital, including joint ventures, offtakes or royalty agreements on existing metal production.
“[T]he combination of depressed valuations and some commodity price slippage may prove at some point irresistible to larger mining players with considerable cash flows. As a consequence, we see a new wave of M&A emerging,” the report notes.
Recent examples include the proposed hostile takeover of Inmet Mining (TSX:IMN) by First Quantum Minerals (TSX:FM,LSE:FQM), the attempt by Alamos Gold (TSX:AGI) to swallow rival gold company Aurizon Mines (TSX:ARZ,AMEX:AZK), and the high-profile pending merger between Canadian oil company Nexen (TSX:NXY,NYSE:NXY) and state-run oil giant CNOOC (NYSE:CEO).
Other challenges identified by Deloitte include: resource nationalism; corruption; the social license to operate; dealing with skills shortages; ensuring a safe environment; and making investments in technology.
Securities Disclosure: I, Dave Forest, do not hold equity interest in any companies mentioned in this article.
Related reading:
Mining Companies Poised for Mergers and Acquisitions, KPMG Study Shows