PERTH (miningweekly.com) – Capital allocations and access to capital were proving to be the biggest challenge facing global mining and metals companies, analyst Ernst & Young (E&Y) found in its yearly 'Business Risk Facing Mining and Metals' report.

Global mining and metals leader Mike Elliott noted that the capital dilemmas threatened the long-term growth prospects of the larger miners, as well as the short-term survival of the cash-strapped juniors.

Rounding out the top three risks for 2013/14 were margin protection and productivity improvements, as well as resource nationalism.

“The rising business risks that are top of mind with mining and metals CEOs and boards today are being driven by the need to protect returns and manage the interests of varied and, often competing, stakeholders. This is in stark contrast to just 12 to 18 months ago, when fast-tracking production was still top of the agenda and capacity constraints defined the key business risks,” said Elliott.

He noted that, for larger miners, the rapid decline in commodity prices in 2012, rampant cost inflation and falling returns have created a mismatch between miners’ long-term investment horizons and the short-term return horizon of new yield-hungry shareholders in the sector.

“Many years of high growth in earnings, cash flows and capital appreciation has attracted a different group of investors to mining; investors with short-term investment horizons, who are not as comfortable with the sector’s longer-term, and often counter-cyclical, development, investment and return horizon,” Elliott said.

“Shareholders with very short-term investment horizons do not seem to understand that every shovelful of dirt miners pull out the ground is a shovelful closer to not having a business – investing in growth is fundamental for the sector.”

Elliott noted that this raised the question of how to balance the demands of short-term shareholders with those investing for longer-term returns.

“There is concern that the pendulum may swing too far, raising the possibility of another period of endemic underinvestment in new supply and resulting in future price volatility.”

“There is a profound risk that the decisions taken by mining and metals companies today could damage their growth prospects, destroying shareholder value over the longer term.”

For the junior miners, the dramatic and continued sell-off in equity markets has starved sources of capital, said Elliott, adding that advanced juniors and midtier producers had been caught in the middle, exposed to a fragile balancing act between investors’ thirst for yield and low tolerance of risk.

He noted that the cash and working capital position of the industry’s smallest companies underlines the severity of the situation. Companies with a market value of less than $2-million, about 20% of listed mining companies across the main junior exchanges, had, on average, less than $1-million in cash and equivalents on their balance sheets at the end of December last year.

Meanwhile, the E&Y report pointed out that a decade of higher prices had concealed the impact of rampant cost inflation, falling productivity and poor capital discipline in the resources sector.

The softening of commodity prices in 2012 and rising costs created a perfect storm to squeeze margins and drive down profitability, the report said, adding that, as a result, margin protection and productivity improvement had jumped to number two in the risk rankings.

Elliott said that, while some of the factors squeezing margins would ultimately self-correct as mineral prices fell, companies still needed to deal with operating costs and capital allocation.

“Productivity in the sector has been on the decline for nearly a decade, across manpower, equipment, processes and logistics. Those who have tackled costs early are now focusing on optimising productivity through more judicious use of labour and equipment.”

Resource nationalism also remained prolific around the world and continued to be a critical issue for mining and metals companies, the report found.

Elliott added that increasing taxes and royalties, mandated beneficiation, government ownership and the restriction of exports continued to spread across the globe.

“As resource nationalism has become more endemic, mining and metals companies have become better at managing this risk. There are some signs that the retreat in capital investment by the sector may see governments take a more considered and cautious approach, but the mining and metals sector must continue to engage with governments to foster a greater understanding of the value a project brings to the host government, country and community.”