Australia’s Mines Hit Crunch Time

25 November 2008 (Last Updated May 31st, 2018 16:44)

Three months after helping Australia post its second biggest trade surplus of all time, the Australian mining industry is sending out some alarming smoke signals. What’s going on? Paul French investigates.

Australia’s Mines Hit Crunch Time

Thanks to its abundance of natural resources and an ever-improving transport infrastructure, Australia "continues to be the world leader in mining", according to Business Monitor International’s 2008 Australia Mining Report.

The world’s largest exporter of coal, lead, diamonds and zinc, the second biggest exporter of gold and uranium and third on the list of aluminium exporters globally, the Australian mining industry value added increased 22% to A$71.8bn in 2006/7 and contributed 37% of Australia’s total exports.

"Between April and October, this year shares in BHP Billiton fell 60%, Rio Tinto sank by 66% and Xstrata 75%."

In October, the Australian Bureau of Statistics revealed that the country had an August trade surplus of A$1.36bn, the largest in over a decade and the second biggest of all time, thanks to a 26% surge in coal and a 5% jump in iron ore exports.

This led some economists to believe that the mining sector was so strong it could guide Australia past the rocky outcrops of recession, yet just three months later the industry is showing signs of extreme caution bordering on desperation. So what’s going on? What’s behind the cautionary activity? And what does the future hold for the world’s mightiest mining economy?

Share prices

One of the most obvious outward indicators that all is not well within the Australian mining industry is share prices. Between April and October this year shares in BHP Billiton fell 60%, Rio Tinto sank by 66% and Xstrata 75%.

Senior associate at Australian mid-tier investment and advisory house Inteq Andrew Rowell says the junior end has especially been hit by falling share prices.

"Their share prices have been hit dramatically hard actually, especially on the junior end and probably unjustifiably so in that most of these companies have got projects into production," Rowell says.

"They're producing cash flow. They're still profitable and yet the market is basically putting in a doomsday prediction that everything is
going to fall apart."

Capital expenditure

"With commodity prices falling and funding options drying up because of the credit crisis, few mining companies are now willing to commit the vast sums of cash for expansion."

Another indicator of the gloom permeating the Australian mining sector is capital expenditure. Net capital expenditure in 2006/7 was A$27.6bn but, with commodity prices falling and funding options drying up because of the credit crisis, few mining companies are now willing to commit the vast sums of cash for expansion in 2009 that they had promised previously.

In November Fortescue Metals Group announced that it would delay a proposed A$2bn expansion, Kagara revealed it is putting its A$35m investment to finalise the Mungana base metal treatment plant in Queensland on hold and Rio Tinto admitted it would review near-term spending on growth projects. Analysts predict expenditure from iron ore juniors will fall from a projected US$15bn to just US$2bn next year.

"Capital expenditure has been affected since the markets started to fall in November 2007," Rowell says.

"Access to capital is difficult, especially for the smaller companies, with banks squeezing them. Rather than the standard 50/50 agreements, banks are asking for 70/30 equity to debt arrangements and people are thinking ‘hang on: this isn’t a good spot to be in’."

Production cuts

In line with a decrease in spending, many companies have recently announced they intend to cut production levels. Mincor Resources originally planned to produce 19,500 – 20,500 tons of Nickel but is now targeting 16-19,000 tons. Rio Tinto will now ship 170-175 million tons (Mt) of iron ore from Pilbara this year instead of the intended 190-195Mt and even BHP Billiton produced nearly a million tons of iron ore less in October than September.

"Everyone has moved into preservation-of-cash mode," Rowell says.

"If it can’t be guaranteed that a sale will go through at a higher price, they (mining companies) are cutting back on production and hoping to ride it out until next year when the market shifts. There’s been very few actual closures though—[it’s] more of a scaling back of operations."

Recruitment freeze

According to the Australian Bureau of Statistics 117,500 people were employed in the Australian mining sector at the end of June 2007, with A$11.8bn paid in wages in 06/07 at an average of A$100,000 per person.

"Companies have very quickly moved from a mode of employing to not employing, while they wait and see how the global situation will play out."

Mining has been a golden sector for employment in Australia but in November Steve Heather, the managing director of recruitment agency Mining People International, admitted that 'companies have very quickly moved from a mode of employing to not employing, while they wait and see how the global situation will play out'.

Not only is there a recruitment freeze, existing staff are actually being laid off across the industry. In recent weeks zinc miner CBH Resources slashed staff at its Endeavor mine by half, Perilya let more than half of its Broken Hill lead, zinc and silver mine staff go and Consolidated Minerals, Poseidon Nickel, Newcrest Mining, Mt Gibson Iron and nickel miner Minara Resources have also announced staff cuts.

"Companies were employing people with no experience because they had no choice but for the short term they won't have to do that any more," Heather says.

"Mining companies will be more choosey. Exploration has been the hardest hit. It has basically been turned off over night."

This is not all bad news, according to Rowell, who says the current economic climate is bringing a more realistic air to the wages given out in the mining sector and will actually benefit the companies involved.

"Mining personnel have had a pretty good run the last few years. They’ve been able to walk in and command whatever salaries and terms they like," Rowell says.

"Now, especially in the nickel sector, companies are getting better quality candidates coming forward and on more reasonable terms."

Mines shut

In the last 18 months at least ten mines, predominantly gold, have been shut down across Australia as a downturn in commodity prices has convinced miners to give up on areas where the resources have been taxed by years of excavation.

"We certainly won’t be seeing too many new mines next year," says Andrew Rowell.

"And I suspect we will see more mines shut down. "If prices stay the same, cash will be eroded and the banks will call in their debts or the companies themselves will decide it’s not worth carrying on."

Commodity prices

So what’s causing the most powerful mining economy in the world to batten down the hatches? One of the key drivers is the credit crunch. Fears of a global recession have caused commodity prices to slump over the last six months with nickel, which was valued at more than US$30,000 a ton on the London Metal Exchange at the start of the year slumping to below US$10,000 in November.

"The current problems are being exacerbated by hedge fund selling of commodities," Rowell says. "When the money is coming in it’s great but when it is going out it seems to rush out in a tide. It’s like a curse and the credit crunch is the sentiment behind it."

China

The great white hope for the Australian mining industry was China. The Chinese are the world’s biggest consumers of iron ore products and buy 40% of their stock from Australia, accounting for 50% of BHP Billiton’s iron ore output and 55% of Rio Tinto’s.

It was hoped that these enormous mining-driven export sales would insulate Australia from the worst rigours of the global economic downturn. However, Rio Tinto chief executive Tom Albanese’s public admittance in October that the Chinese economy was "not completely insulated from an OECD recession and we will see an impact on Chinese exports", was followed by further tumbles in share prices, production levels and commodity prices.

And there’s more pain to come says Australia & New Zealand Bank chief commodities strategist Mark Pervan. "China’s largest iron ore port normally receives ten vessels a week and they are currently receiving only four," Pervan says.

Outlook

"When China’s stimulation package kicks in, demand will accelerate quickly over the next 12-18 months."

The obvious reaction within an industry facing financial issues like the Australian mining sector is a raft of mergers and acquisitions (M&As), and that is exactly what is going to happen, according to Iteq’s Rowell.

"There will be a lot of M&As coming up as companies at the junior end, perhaps sitting on A$5 – 1m in cash, will either have to do a deal or call in the administrators," he says.

"The big question is what will happen with BHP’s attempted takeover of Rio Tinto? I think, in the current global crisis, the offer gets better by the day, the reasoning behind creating one powerful company grows stronger and the arguments of the regulators is diminished."

The Australian mining industry will be made stronger as the mass of companies merge together to form leaner, fitter organisations. And, with demand anticipated to increase from overseas, Andrew has no qualms about predicting a bright future for the world’s biggest mining sector.

"There’s a lot of posturing coming out of Rio and BHP at the moment as they negotiate with China on price but I’m not expecting massive drops to the levels of a couple of years ago," he says.

"Rio and BHP are scaling back projects but there’s enough anecdotal evidence to suggest that when China’s stimulation package kicks in, demand will accelerate quickly over the next 12-18 months.

"And there’s been a huge step up in demand from India over the last three months. We’re getting at least one or two queries a day from companies wanting iron ore, coal and base metals. Indian companies are becoming quite proactive after spending the last few years playing second fiddle to China, and that can only be good news for Australia."