Title: Cost containment key rising risk for mining companies

Sub-title: A report by Ernst & Young says that the financial crisis and global recession have changed the environment that Canadian players face.

 

The global financial crises has created new risks that threaten the near term survival of a number of mining and metal companies. However opportunities have also emerged for well-capitalized companies to position themselves for the upturn. Those are the key conclusions of Ernst & Young’s Strategic Business Risk Report 2009, released last month.

 

The report notes some of the major changes that have beset the industry. The document highlights risks that mining sector players face and assesses how those risks have evolved during the past 12 months.

 

Not surprisingly, the 40 percent drop in the London Metal Exchange Index that occurred between July 1, 2008 and July 1, 2009, has made things much tougher for the industry s says Tom Whelan, Ernst & Young’s Canadian leader for the mining and metal industry. “Access to capital has been choked off for most companies, with the rare exception of those in the gold sector and maybe a few others.”

 

Tightening the boot straps

The upshot is that producers are now increasingly focused on cost containment, which the Ernst & Young report lists as the biggest risk that the sector faces. “We went through a period during which commodity prices rose rapidly to unprecedented levels,” says Whelen. The desire by operators to produce and sell as much production as possible while the prices were so good led to bottlenecks in the supply chain for basic inputs ranging from skilled labour to energy and delivery infrastructure. “This “produce at all costs” mentality led to sloppiness and cost overruns which are totally unsustainable at current price levels,” says Whelen.

 

Many mines responded to the drop in commodity prices by shutting down production. However many others that continue to produce will need to get their costs back into line. The key says Whelan is that cost reduction activities need to be implemented in a way that does not lead to value erosion.

 

The Ernst & Young report recommends several steps that mining and metals companies can take to respond to cost containment risks. These include focusing on areas that provide maximum value, embedding cost optimization to make sure that the savings achieved are sustainable and ensuring that company leadership is visibly committed to achieving a single definition of success.

 

Some risks have decreased…temporarily

Of course not all risks have increased. In fact, slowdowns or shutdowns at many mines sparked by shrinking demand, have given companies slack in several areas once judged far more critical. For example skills shortages, once a major threat due to the rising average age of workers in several key job categories, are not as prevalent as they once were.

 

In a similar vein, reduced or halted production by many operators has meant that a lot of those mines will be around longer. That means that pipeline shrinkage is less of a concern. Getting access to scare infrastructure is also easier now.

 

Reduced remand has also weakened the hand of many countries and regions who were seeking to attract investors willing to develop local deposits. As a result, resource nationalism and the ability of miners to obtain or maintain social licenses to operate, no longer provide the same “bargaining chip,” threats they once did. Despite this, Whelan counsels clients not to succumb to the pressure to cut spending on initiatives to build bridges with local communities where mines operate.

 

Much discussed, always fully reported

Reports like the Ernst & Young document provide particularly useful information for mining sector stakeholders. The long life cycles inherent in almost all mining sector projects means that correct risk profile assessments of current and planned initiatives is crucial. For example is if potential threat combination to a planned investment has only a one in 20 chance of occurring in a given year, the risk may seem acceptable. However if that mine is expected to be in operation for 20 years, then the probability rises to close to  100%.

 

 “At the end of the day, the mining industry is full of risks,” says Whelan. “(As a result), risk management is one the top topics of conversation at board levels.” Despite this, risk reporting is not formally mandated under current accounting guidelines.

 

“The management discussion and analysis sections of company financially statements do include a risk section. But the information there is kept fairly generic,” says Whelan. The upshot is that to fully assess the risk that beset mining industry operates under, stakeholder will generally have to research of their own.

 

Whelan also made interesting observations regarding the effects that consolidation has had on the industry. “Our research shows that companies that are emerging out of the crisis fall into three categories. They are either opportunists, innovators or survivors,” says Whelan.

 

The key says the mining sector export is to stay focused on the big picture. “Getting access to financing is a major challenge. As a result, the short term investment picture may indeed look grim” says Whelan. “The IPO market has essentially been closed down, so we are telling our clients that if they have a chance to get a hold of capital they should seize it.”

 

“The demand for resources will almost certainly start to rebound again,” says Whelan. “Lack of available financing has created fabulous opportunities for those who have a longer term horizon such as the Chinese companies who recently took positions in Consolidated Thompson Iron and Tech Resources.”

 

 

 

An executive summary of the Ernst & Young report is available at:

 

http://www.ey.com/Publication/vwLUAssets/Industry_Mining_Strategic_business_risk_2009_2010_Mining_metals/$File/Global_strategic_business_risks_report_Mining_and_Metals%20.pdf

 

A full copy is available at:

http://www.chamber.ua/files/documents/updoc/tax_legal/19/Strategic_business_risk_report_Mining_Metals_2009.pdf

 

 

 

Sidebar: The top 10 strategic risks that mining sector players face (according to Ernst & Young):

 

  1. Cost containment

  2. Industry consolidation

  3. Access to capital

  4. Maintaining a social license to operate

  5. Climate change concerns

  6. Skills shortages

  7. Infrastructure access

  8. Access to secure energy

  9. Resource nationalism,

  10. Pipeline shrinkage

 

Peter Diekmeyer is CIM Magazine’s Quebec correspondent.

 

-30-


Home | Economics| Foreign Affairs | Magazine/Government| Gazette | Books |

 

peter@peterdiekmeyer.com

  © 2009 Peter Diekmeyer Communications Inc.