Deloitte urges focus and discipline

In its annual report on mining trends, financial consulting firm Deloitte has a message for industry players: don’t sacrifice future growth in the name of short-term capital savings. Deloitte further runs down its picks as the top-10 issues facing mining companies in 2013.

In what has become an industry trend, major miners are opting to defer capital-intensive development projects during unpredictable commodity prices and a volatile global economy. Deloitte says difficulties within the eurozone and weakening demand from China are underpinning the movement, as mining companies struggle to forecast demand for commodities.

Deloitte expects capital spending in the sector to rise by 13% in 2012, and likely to fall in 2013.

“Despite near-term tapering demand, the world remains at risk of long-term supply constraints. This danger will grow as companies halt production in the face of capital cost increases and growing shareholder demands for more immediate returns,” Deloitte Americas mining leader Glenn Ives writes. “Although companies are hesitant to invest aggressively, one thing is clear: failure to replace depleting assets will result in higher future commodity prices. Significant rewards will be available to the companies that invest today.”

For a second straight year, cost inflation headlined Deloitte’s report, with higher prices compounded by weakening commodity valuations over the past 12 months. The result has been cost overruns at many large-scale development projects, resulting in weaker share prices and challenging capital markets.

The report cites research from Metals Economics Group that found that costs at over 20 major copper projects rose by “20% to 140%, without a corresponding jump in reserves.”

According to Deloitte, the answer to cost overruns lies in financial discipline when it comes to selecting projects. The firm describes a frantic “push to production at all costs,” where miners have chased more marginal deposits in challenging jurisdictions.

A related industry-wide criticism has been squarely aimed at project-scoping processes and risk-assessment methods. In a bid to portray a deep project pipeline, Deloitte argues that many companies are advancing lower-grade deposits with higher risks.

The trend also has the effect of stretching capital over too many projects, where companies would be better served focusing on a selection of higher-margin investments. The report encourages miners to invest in feasibility and scoping work and have a strong set of development options, as markets recover over the mid- to long-term.

“As shareholders pressure mining companies to improve returns through dividend yields, cash flow becomes more critical,” Deloitte South African mining industry leader Abrie Olivier writes. ­“Volume growth is no longer a measure for success. Instead, mining companies need to pursue ­quality over quantity and focus on profitable production, while striking a balance between generating cash and growing revenues.”

A second major theme in the report addresses growing socio-political complications mining firms are encountering in emerging jurisdictions around the world.

These concerns involve growing resource nationalism and increasing uncertainty in regards to taxation and ownership. Miners have been dealing with exploration and operating permit complications, as well as increased taxation and profit-sharing with governments.

“Combined with mounting community demands, the difficulty in obtaining local licences, social and environmental mandates and labour union pressures, it is getting increasingly difficult to justify a large number of mining projects to investors and financiers,” Deloitte Queensland mining leader Reuben Saayman writes.

Companies have tried to address these concerns by building stronger in-country relations and working with governments to create better royalty and taxation models.

Deloitte cites a situation in Peru where the central government consulted local mining associations to create an ­acceptable royalty regime. Another important step for miners, Deloitte argues, would be further establishing jurisdictional diversity to hedge against geopolitical volatility.