Where do miners go from here?

The shift from quantity to returns have led to numerous headaches for miners with project delays, hefty write downs and CEO departures as companies struggle to tackle escalating costs that have caught up with the rising commodity prices, said Lee Hodgkinson, the national industry leader of KPMG’s Canadian mining practice.

KPMG is a global network of firms that offer audit, tax, and advisory services for various industries, including the mining industry where it also advises on strategy, growth, performance and compliance.

Hodgkinson, a chartered accountant by training who specializes in mining, said over the past decade there has been a rise in commodity prices driven by urban population growth, particularly in China, which has fueled the need for base metals. In addition, the weakening of the U.S. dollar has bolstered the gold price as countries are buying more gold.

“This should have led to incredible returns for the companies and their shareholders. But instead what we’ve begun to see is a significant separation between commodity and equity prices,” he said while moderating KPMG’s panel at the recent Prospectors and Developers Association convention.

He points out for gold stocks the impact of exchange-traded funds or ETFs cannot be overlooked as they provide an alternative to the many risks — such as development, politic and management — that come with equity stocks.

There’s also a general decline in mine reserves, pushing up operating costs as organizations have been building larger, more capital intensive projects to mine lower grades, he notes.

Refocusing on returns

It’s only recently that firms have started steering away from growth to focus on returns as commodity prices have leveled off and capital markets have dried up, Hodgkinson said, noting investors are punishing companies with big pipelines. In response companies are tightening their purse strings and halting capital demanding projects. “Is this a good strategy?” he asked KPMG’s advisory panel featuring Brad Watson, Augusto Patmore, Simon Beer and David Waldron.

So with the tight capital markets, miners are putting the brakes on production growth, maybe stopping some of their projects and focusing on operations, said Waldron, a management consultant. He concedes this is a good strategy, but adds companies have to consider trade-off studies before trimming their pipelines.

“The acid test here is: do the projects actually through your pipeline and opening your pipeline, do these projects actually improve your financial position that your company is going to have in generating results? Can you actually swap smaller projects for the bigger ones you’ve announced before? Can you actually consider situations where you would open the pipeline in favour of dialing back on some of your current operations? Could you think of a situation where the new project is going to generate better cash results than your past operations? So those are some trade-offs you can do,” said Waldron, whose areas of expertise include business strategy and planning.

Part of the answer is the market will likely stop punishing companies that deliver on their story and promises, he notes.

Cost drivers

Patmore, an engineer by trade who has spent 17 years managing large infrastructure and mining capital projects, said he sees three key issues that are driving up costs for mining projects.

The first is the inadequate risk transfer mechanisms that are built into contracts. “We see a trend of large mining companies hiring EPCM firms to manage their design-build process and billing their whole responsibility to the EPCM, however the risk the mining company is taking in executing that project is not transferred to the EPCM firm,” he explained.

He proposes to reduce unexpected costs the risk has to match the responsibilities of all the parties involved in the project. He says mechanisms such as incentives, bonuses, the correct description of commissioning, wrapping up and contract closeouts procedures should be properly analyzed and written in contracts.

Secondly, he notes scope changes in a project due to designs that are not complete or advanced enough often result in higher costs.

For underground projects he points out the most common pitfall pushing up costs is an inadequate description of ground types because not enough bore holes were done on a tunnel before designing a mine plan, leading to errors in budgeting, forecasting and estimating workforce.

After stressing the importance of early project planning to define a project, he says companies have to consider where and how to source their equipment, supplies and workforce.

Based on his personal experience, he points out firms in developing nations, such as Chile, that hired a few skilled international expatriates early on often reported better productivity.

“Bringing two to three people out of the fifteen- to twenty-people team from abroad, but having those key people in at the early stages really increases your productivity. It may look like a high cost and an unnecessary cost in the beginning, but believe me it’s not. People need to know what they are doing and people need to have proper training and after that you can train the locals.”

For equipment, some countries may force firms to nationalize the equipment. This is something companies have to consider as it will add to the tab, Patmore says, adding firms need to realize some jurisdictions may have long lead times and limited suppliers available, making it difficult to buy supplies within budget.

“You might be able to get a rebar order in Canada to a construction site in a week, but in Peru it might take fifty to sixty days. That’s just how things work down there… you have to plan for that. You need to know that and built it in your budget.”

Patmore concludes most of these issues can be mitigated by investing more time in planning the project in the early stages.

“A little bit of strategic project execute planning in the beginning is what makes all these things right and what gets your companies in position to have proper contracts, proper suppliers, and the right amount of people working as they should.”

Infrastructure needs

The need for infrastructure is affecting mining companies now more than ever before, said Watson, who heads KPMG’s global infrastructure advisory practice in Canada. He points out companies need to possess a different skill set to develop infrastructure to ensure everything is delivered on time and on budget.

He suggests firms should “plagiarize liberally” when it comes to developing infrastructure, such as roads, power plants, rails, and so on. For example, he says when building access roads, firms could look at existing contracts that the local government has for roads, which will include the terms and conditions for hiring a contractor to perform the work along with the technical provisions and standards.

Similar to the previous speakers, he underlined the importance of integrated planning when companies are in the early stages, noting once firms tack on all the infrastructure requirements to a mining project the complexity grows exponentially.

“Putting a little bit of effort upfront and having a little bit more dialogue initially around the critical path and how the various pieces hang together is critical when you start to talk about a project that is as much an infrastructure project as it is a mining project.”

He notes while there’s a trend for companies to develop infrastructure, there is also an independent trend of institutional investors looking for infrastructure investments around the world, creating an opportunity for mining firms to work with an institutional investor to monetize on a piece of infrastructure.

Watson points o
ut some common problems companies face when it comes to developing infrastructure include poor definition of project scope and not understanding the needs and concerns of the local government around infrastructure.

“You know it is never good press if you are running power lines over dark communities, where there is not going to be electricity in those communities. You have to think of these things,” Waldron adds, pointing out the infrastructure companies build on the social side for the communities are important in sustaining relations.

Improving performance

Beer, who specializes in operations strategy and costs reduction, said the move from volume to value has been a difficult one for companies as cost escalations were initially masked by higher commodity prices.

Focusing on cost-reducing initiatives has been quite hard, but there are some organizations that have been able to reduce costs without negatively impacting their production volumes, he said.

“The key factor for me in all of this is taking an objective, dispassionate view of costs. Ensuring you got complete transparency across the entire life cycle and you are able to identity the specific actions that could really drive some changes in that area.”

He explains there are several areas companies could target, explaining one of his mining clients in South Africa was able to reduce its cost structure by 25% by focusing on labour productivity, energy utilization, and integrated mine process planning.

To increase labour productivity companies should examine exactly what their staff is doing and what activities are driving up costs and systematically go through those activities to see how they could be done differently to boost productivity, Beer says, adding for example when looking at blasting strategies, some companies got better results by simply moving to water gel explosives.

For energy, he says companies could benefit from understanding when and why they need energy and align their needs to low tariff periods, especially in developing nations. Beer adds even better results could be achieved if companies do this while using energy efficient equipment.

Moving to integrated mine and process planning, he pointed out firms need to grasp the full value chain of activities from mining through concentrating, smelting and refining to identify cost savings.

Beer concludes if companies could prevent “stoppages, blockages, backups and shortages” in their value chain it could drive some step changes in performance.

‘Selecting away’

But before going through all these cost containment exercises, firms could reduce their troubles by carefully choosing projects, Waldron said.

“Selecting away from projects is equally as important in containing your headaches as selecting projects that you are going to do.”

Once the selection is complete, Waldron notes companies should plan how they will deal with different possible scenarios, such as resource nationalism, that could crop up.

“You want to avoid the headaches, so go ahead, understand your risks, understand what you are capable of accepting. Make sure when you select your projects that you are very cognizant of what you choose not to do and simply don’t do it. Finally, when you planning, plan it out in scenarios and get on that path and know what the exit ramps are just in case you do have to exit,” he said.