TSIDISO DISENYANA Low-cost producers stand a better chance of success, even in a depressed commodity market, than those in areas where production costs are high
There should be greater scrutiny in terms of economic risk factors amid contractions in the global mining sector, in view of the prolonged downturn in commodity prices and uncertainty in global demand, when evaluating new mining projects, South African risk insurance provider Export Credit Insurance Corporation (ECIC) senior economist Tsidiso Disenyana advises.
This is especially relevant to projects in some developing African countries, which are exposed to significantly greater exogenous risks than those undertaken in a more diversified market, he says.
“The success or failure of mining projects is a function of the interplay between operating costs, the quality of ore grades, output capacity and price,” says Disenyana. He maintains that, when evaluating the viability of a mining project, more heed should be paid to issues such as debt sizing assumptions; the capital structure, financial strength and expertise of a project’s equity partners; the suitability of repayment terms; and the ability of debt service coverage ratios to withstand robust stress-test scenarios.
The protracted period of depressed commodity prices, notes Disenyana, has not only affected corporate balance sheets but also the sovereign ability to honour external obligations. Most governments are unable to meet their contractual obligations, with low fiscal revenue collection and continued currency depreciation. At a corporate level, single-asset junior mining companies are struggling to contend with the slump in commodity prices and the difficulty in raising additional capital in the equity markets to fund their projects.
“These companies are becoming more vulnerable to hostile takeover bids and the overall credit risks are increasing, although companies mining commodities, such as gold and diamonds, might still have a chance, as demand for those commodities is less affected by the economic slowdown in China,” Disenyana says.
These challengers are, moreover, aggravated in African mining regions, where the level of infrastructure development and the depth of the private sector and supply value chains are still in their infancy. Disenyana highlights that projects exposed to this kind of environment face higher risks than if, for example, connection to the power grid is already in place and power supply arrangements are reliable and relatively cheap.
“In short, low-cost producers stand a better chance of success, even in a depressed commodities market, than those in areas where production costs are high.”
Disenyana adds that, while companies can, to a certain extent, rely on the expertise and experience of adequately resourced management teams and well-established and proven technologies, execution risks still remain constraints, especially during a project’s construction phase and ramp-up period of the production phase. Therefore, he suggests that pre-emptive measures be taken to manage these risks.
For example, hedging a portion of a project’s gold output might mitigate price risks, provided the operational risks – which might negatively affect output – are dealt with. Another mechanism Disenyana suggests to mitigate market and price risk is for suitable commodities to enter into long-term offtake agreements on fixed pricing, volume and tenure on a take-or-pay basis with creditworthy counterparties.
The ECIC underwrites bank loans for the financing of the export of South African capital goods and services. Mining projects constitute about 36% of its portfolio, with the corporation involved in copper mining in Zambia and diamonds in Lesotho, as well as gold in Liberia, Tanzania and Zimbabwe, among others.