Massive capital allocation challenges cause headaches for mining, metals
An Ernst & Young report has identified capital allocation as the foremost risk for global mining and metals companies.
Mining-related skills shortages jumped to second spot on E&Y’s Top Ten risk rankings, while cost management came in third and resource nationalism concerns were ranked fourth.
In Ernst & Young’s annual Business Risks facing mining & metals report 2010, Global Mining & Metals Leader Mike Elliot noted, “Volatility across commodity prices, cash flow, risks appetites and availability of capital are driving massive capital allocation challenges for mining and metals businesses.”
“The uncertain economic environment and massive changes to expected rates of return, level of gearing, taxes, and the cost of debt and equity, is challenging existing capital allocation benchmarks,” he added.
As a result, the focus of mining and metals companies has shifted from growth by acquisition to more balance with organic growth.
Meanwhile some parts of the mining and metals sector are dominated by companies so big, they have acute capital allocation decisions to deliver growth, E&Y suggested. “For instance, the top three gold miners produced a combined 173 million ounces of gold in 2009. How do these companies allocate capital to replace such high production and provide growth?”
The three top gold miners also face capital allocation issues that many miners would like to have-what to do with all the cash? “At record gold prices, the top three gold miners were holding in excess of US$7b in cash as of 31 March 2010.”
“The capital allocation decisions are whether to use this cash on high priced acquisitions, to fast track expansions or to return to shareholders,” E&Y noted. “These circumstances also lead mining and metals companies to procrastinate on logical divestments as they have no present better use of these proceeds.”
As UK Mining and Metals Leader Lee Downham of Ernst & Young observed, “Now, even the most synergistic acquisitions struggle to attract financing and tier one assets supported by blue chip majors often require the support of strategic investors to gain the necessary funds for development.”
Meanwhile, Canadian Mining and Metals Leader Tom Whelan said, “The skills shortage continues to worsen and addressing it should be key to companies’ strategies.”
The implications of skill shortages can be wide-ranging and include project development and production delays, increased difficulty in meeting contractual commitments, increase safety risks, increased fraud and corruption, reduced competitive advantage, higher operational costs, and declines in productivity.
uring the global financial crisis, mining and metal companies made cuts to protect margins and cash. However, E&Y’s Evgeni Khrustalev, CIS mining and metals leader, cautioned, “Disciplined cost saving initiatives implemented out of necessity during the crisis should be maintained during the recovery to achieve best returns on investment.”
The same global financial crisis that hard hit base metals miners also resulted in shrinking government revenue globally. “Many governments are looking at altering the fiscal terms of economic rent for mining and metals projects in their countries in order to obtain a larger share of higher mineral prices and thereby repair fiscal positions,” E&Y said.
Among the forms of resource nationalism is the Australian Government’s intention to implement a 40% resource rent tax. South Africa’s new royalty regime is another example. Mongolia recently froze on the issuance and transfer of mining licenses until the government can enact a stricter law on foreign mining investment.
The global financial crisis also triggered a number of “use it or lose it” demands from government when lower commodity prices slowed capital expenditures.
In their analysis, E&Y suggested as big mining and metals countries increase their resource nationalism activity, “it will be a signal to other countries to follow suit without the fear of a relative loss in foreign investment.”
E&Y African Mining and Metals Leader Adrian Macartney observed, “Perhaps the way forward is a partnership with stakeholders”
“Innovative partnerships will be needed to demonstrate to these governments the value that mining companies bring by developing resource projects,” he said. “At the same time, companies need to forge strong relationships with government to communicate their needs to facilitate the development of projects.”
Other top 10 mining and metals risk concerns contained within the E&Y report include:
5. Maintaining a social license to operation
6. Infrastructure access
7. Access to secure energy
8. Access to capital
9. Price and currency volatility
10. Climate change concerns
To read the E&Y report, go to www.ey.com/AU/en/Newsroom/News-Releases