During the first decade of the new century, western mining companies were more concerned with production volume than anything else as they rushed to get commodities such as copper, iron ore and coal out of the ground fast enough to satisfy China’s seemingly insatiable appetite for growth.
Ernst & Young’s new report, ‘Business risks facing mining and metals 2016-2017’ vividly illustrates how quickly and profoundly times have changed, and makes for sobering reading for the industry.
“Cash optimisation is the number one risk facing mining and metals companies in 2016-2017, especially given the limited demand and pricing visibility in the wake of market volatility,” states Miguel Zweig, Ernst & Young’s global mining & metals leader. “Mining and metals companies have increased their focus on cash as they seek to maintain strong balance sheets and plan for longer term profitability.
“Securing funding and credit terms has also been extremely challenging, and therefore capital access moved up to the number two spot, as trade and debt financing is extended only to those companies with sufficient security, and at an increased cost, as banks seek to manage the risk of default.
“Productivity remains in the top three risks as many miners struggle to make further improvements, particularly around assets. Companies need to embed sustainable loss-elimination practices through employee engagement, plus an integrated, end-to-end approach to improve long-term productivity.
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“Cyber-security and digitisation are also emerging as greater challenges for the mining and metals sector,” he adds. “As a result, we expect to see them higher in the risks list next year.”
Get smart: capital cost reduction, liquidity and access to financing
The boom and bust nature of mining means companies are especially vulnerable to price and market volatility. Managing liquidity through cost reductions that do not erode value and also improve the effectiveness of working capital is one way that operators can successfully weather volatility.
“We believe there are still opportunities of cost reduction for those willing to challenge the models that emerged in the boom, but companies need to understand what measures need to be made, how quickly they can be made, the payback period and how long they can be sustained,” he says.
“Improvements that mining companies will need to carry out to further release cash from working capital include the reconfiguration of supply chain to better control and manage the purchase and deployment of inventory spares; leveraging better insights from systems and data on the operational drivers of working capital; and cultural change so that all employees who influence working capital understand what they can do to better manage cash across inventory, receivables and payables.”
Why is traditional capital and loan financing drying up, and what alternative sources of financing can mining operators access in order to refinance existing infrastructure and, crucially, new exploration?
“Global mining companies continued to face challenges in accessing conventional finance in 2016 due to a negative sector outlook from falling Chinese demand and resulting weak global commodity pricing,” Zweig confirms. “Credit rating agencies maintained a negative outlook for the mining sector in 2016 forcing companies to consider alternative, and at times more costly sources of capital.
“Following two years of decline, however, aggregate capital raised in the sector actually increased by 9% year-on-year to $249bn in 2016, mainly as a result of the doubling of Chinese proceeds fuelled by a huge rise in domestic corporate bond issues. Commodity prices also rebounded over the course of 2016, positively impacting cash generation. The improved financial performance was also bolstered by cost-cutting measures further deleveraging using proceeds from divestitures of non-core assets.”
The consensus in the mining industry is that commodity prices bottomed in early 2016 and will now gradually pick-up from the lows witnessed in recent years; however, market volatility will persist.
“The expected continued consolidation of commodity prices in 2017 will positively impact the sector outlook and strengthen investor confidence,” states Zweig. “Options for access to capital will begin to improve, though the industry is likely to continue to exercise capital discipline in the short-term, prioritising the retiring of high-cost debt accumulated through the distress period in order to reduce cost of capital.”
“Cash generative major players set the tone during 2016 with bond buy-back transactions aimed at lowering capital costs. This trend is likely to continue into 2017 as the sector cautiously gauges the sustainability of the recovery in commodity prices before investing for the next growth cycle.
While improving industry outlook is likely to attract private capital, the gulf between buyer and seller asset valuations will continue to limit the volume of deals until the sector growth outlook becomes clearer and those with synergies or a strategic agenda will be able to justify a higher valuation.”
Value judgements: productivity, innovation and digitalisation
Turning to number three in the risk list, productivity, I ask Zweig to expand on EY’s theory that long-term improvement can be achieved by focusing on assets as a business system, the pursuit of loss and supporting people in the organisation who play a critical role in productivity transformation.
“Mines were scaled up in the boom time to maximise production, but managers were not provided with the tools to manage this increased complexity,” he says. “Adopting of an end-to-end process model/business system approach provides for greater communication and transparency across the line, leading to better and more timely decision-making, and ultimately to improved productivity.
“The relentless pursuit of loss refers to productivity improvement and value creation through the adoption of a manufacturing mindset and digital transformation. One company places its safety equipment in vending machines accessible by staff cards, allowing for a better ‘think before use’ approach, resulting in millions of dollars in annual savings and cuts in safety equipment usage of 50% at some sites.
“The role that people can play in the productivity transformation cannot be underestimated. Visible leadership and significant investment in culture change and capability – from operations to the CEO − are critical if mining companies are to reach the next level of productivity.”
What new types of transformative mining innovation are required and are companies relying too much on technology at the expense of a more forensic evaluation of business fundamentals?
“We have observed many operators focusing on innovation as a driver for short-term, bottom-line improvement,” says Zweig. “Our view is that innovation needs to be a mix of short and long-term − but ultimately should be a driver for long-term returns. Digital is an opportunity to optimise plans and productivity rates, and will help miners navigate toward a manufacturing level of excellence.”
Forward thinking: commodity prices and long-term strategy
With pressure mounting on the industry to cut costs and improve margins, Zweig identifies several interesting trends as operators look to balance short-term priorities with long-term value creation.
“Companies are facing a difficult choice about how to allocate capital and create value,” he says. “There is a need to build a business that is more sustainable, resilient and profitable throughout economic cycles. We are seeing more quality assets coming to the market and well-capitalised producers continue to look for opportunities, especially if they are low-cost, de-risked operations with output readily marketable to end users.
“There are definite signs of improvement in the mining and metals sector, for example, rising commodity prices due to cuts to supply and stronger than expected growth in China, and increasing cost discipline has resulted in improved revenue for mining companies in the second half of 2016.
“We are still seeing a division in the fortunes of different commodity markets. Commodities in which the long-term supply/demand fundamentals are more positive are drawing the most attention such as nickel, zinc and copper, with several miners announcing that they will be boosting CAPEX in 2017.
“Elsewhere, the effect of Chinese regulation has yet to play out fully and the sustainability of price surges in coal and iron ore prices is uncertain. Several coal miners both in Australia and the US, for example, have commented that they will neither bring production back nor increase it to take advantage of current coal prices. This signifies a move away from building production at any cost.
“With the economic outlook remaining volatile, there may be further revisions to long-term metal price forecasts, but it’s not about predicting the future − it’s about preparing for any future. This is where mining companies have gone wrong in the past and where they have an opportunity now.
“The key is agility and a productive, well managed, cost effective, end-to-end value chain. A change in mindset is an enabler to this – companies need to break free of pro-cyclical short-term behaviour and instead consider the impact of their actions on long-term productivity and future growth.”