A dramatic change in the operation of mines has recently taken place and continues as the industry seeks to align itself with new market demands and overcome supply issues.
Audit, consulting and advisory firm Deloitte states in its ‘Mining – Finding the Balance’ report, released last month, that the two major factors currently affecting mining operations are decreased demand of raw materials from China and oversupply thereof by miners.
The catchphrase for the commodities supercycle at the start of the century was ‘stronger for longer’, as the industry predicted prolonged growth, underpinned by China’s expected continued growing demand for raw materials. Since 2002, China has been the main driver of global demand, as it consumes about half of global commodities. During this time, miners spent freely on acquisitions and capital projects to ensure that the supply of coal, oil and metals met market demand, which was led by China.
However, since 2011, there has been a consistent decline in commodity prices, owing to being a significant number of large investments – launched at the start of the century – delivering increased supply to the market.
This increase in supply coincided with a change in dynamics of China’s industrial sector, as it shifted from being an investment and export-led economy to being a consumer-driven one. This has resulted in reduced demand from the mining sector.
Last year, China’s growth slowed to its lowest level in 25 years, while commodity prices plunged to 1999 levels. The mining sector regards this as the end of the commodity supercycle, while there are speculations that commodity prices might drop even further.
In terms of metals commodities, prices declined as much as 30% in 2015 and are expected to decrease a further 9% this year. However, since the start of February, Deloitte has noted metal prices increasing, as a result of the Chinese and the European Union governments’ commitments to encourage economic stimulation. It is still unclear whether the current rally is sustainable or whether it has slowed or stopped the metal price decline.
Adapting to the current oversupply in the market might not be as straightforward as simply reducing output from mines, as other market factors are influencing decision-making.
To curb oversupply issues and weak trading prices, some mining companies have resorted to either mothballing operations or selling them to prevent losses.
Last year, coal mines and steel plants closed or downsized in the US, the UK and Europe. In Africa, mining majors closed copper and platinum plants, owing to low market prices no longer being able to justify production of these metals.
However, certain large mining companies are continuing production to drive out competition, which is similar to behaviour in the oil sector.
“It is common and, in fact, sensible for miners to focus on operational and cost optimisation, particularly in times of suppressed commodity prices,” says Venmyn Deloitte director Neil McKenna.
He adds that many miners are facing the harsh reality that unless drastic changes are made – such as closing unprofitable mines or cancelling developments – they will not survive.
“Many such decisions might become irreversible . . . it is, therefore, critical that miners find the right balance between cost cutting and investing in the future so that they can remain com- petitive when the market turns. And it will.”
In terms of efficiency and cost cutting, Deloitte claims that decreasing energy costs have helped miners to partially offset reduced revenues. However, for major and junior mining com- panies, the key to survival is increasing productivity efficiency and containing costs.
In this regard, labour might be regarded as an easy option. Deloitte says between 40% to 50% of mines’ costs relates to labour, adding that miners should, therefore, consider labour in their efforts to maximise efficiency.
However, the firm warns that reducing staff has associated political, economic and social risks, thereby requiring transparent communication between management teams and labour groups.
In the medium term, Deloitte predicts that miners will focus on strengthening their balance sheets through capital austerity, cost savings, working capital management and reduced dividends.
Mergers and acquisitions are expected to increase as a result of cash constraints and the need to generate efficiencies across the industry. This includes asset divestments, distressed sales and strategic bolt-on deals.
Deloitte also predicts further polarisation and consolidation of the sector, as miners with strong balance sheets are best placed to acquire other operations, while smaller contenders are constrained.
A shift in the source of demand is also expected, with India taking over from China. This will require a rebalancing of customer relationships and distribution channels.
Lender dynamics could also be challenged, as existing lenders are asked to amend and extend faci- lities and wait for the commodity cycle to turn in favour of the industry.