Will cost inflation challenge supply growth?

Capex costs in the copper mining industry rose 33% on average in the fourth quarter of last year leaving in their wake “no shortage of examples of cost blow outs this year,” Barclay’s commodities research team pens in a new report published May 9.

Earlier this month Inmet Mining (IMN-T, IEMF-O) announced that projected capital costs for its Cobre Panama copper project have increased to US$6.2 billion from an earlier estimate of US$4.3 billion in March 2010, while estimated costs at Antofagasta’s (ANTO-L, ANFGY-O) Antucoya copper project in Chile have risen from US$1.3 billion in December 2011 to US$1.7 billion in May 2012. In late April Baja Mining (BAJ-T, BAJFF-O) announced that capital costs at its Boleo copper-cobalt-manganese project in Mexico have increased by $246 million or 21.5% over the 2010 funding requirement, and later said that without a cash injection before mid-June the project may have to be suspended.

Higher costs stem from everything from shortages of skilled labour and prices for equipment to environmental compliance and extended project development times.

“Record high and still rising industry costs are now in our view beginning to threaten the medium-term supply outlook,” Barclays’ analyst Gayle Berry argues, “in part because of the difficulty in securing enough finance, especially in the case of smaller companies, but also in part because of the erosion effect rising costs have on the economic viability of a project.”

Meanwhile producers like Rio Tinto (RTP-N, RIO-L) and BHP Billiton (BHP-N) are reassessing development plans for some of their projects.

“Large diversified miners appear to be reviewing plans for several large-scale development projects, which could indicate they are hearing investment community concerns about ambitious development projects,” Adam Graf of Dahlman Rose & Co. writes in a note to clients. “Concerns over slowing Chinese growth and increasing labour costs have caused companies to review how capital will be deployed in the future.”

Graf noted that his industry sources have indicated that Rio Tinto is reviewing its US$2 billion thermal coal project in New South Wales. “Tom Albanese CEO, recently stated that some of the company’s development projects would be pushed back as RIO will focus on its most profitable opportunities,” Graf said. “Similarly, Alberto Calderon (BHP’s Aluminum Group Executive) indicated that the company would closer align capital spending with cash flows.”

Barclays notes that its own equity analysts have “opined that miners should be investing less in capital-intensive growth in favour of higher returns to shareholders.” But that approach will have a significant impact on future metal supply.

“This has implications for the realisation and timing of the future projects and, in the case of copper, for instance, poses a challenge to consensus expectations for strong future supply growth,” Berry argues. “Although on paper the list of potential new projects is long, realising that growth could be quite different. Indeed it is telling that even in the current high price environment, miners are struggling to justify investing in new projects.”

Graf of Dahlman Rose adds that a number of large BHP projects including Outer Harbour (iron ore), Olympic Dam (copper/uranium), and Jansen (potash) “have not yet been fully approved, although no delays have been announced either. If these companies pull back from any projects it should help to extend the commodity cycle.”