Capital allocation and access to capital have rocketed from number eight in 2012 to the top of the business-risk list for mining and metals companies worldwide, global auditing house Ernst & Young states in its yearly ‘Business Risks Facing Mining and Metals 2013-2014’ report, released last month.

Ernst & Young mining and metals sector leader for Africa Wickus Botha says these capital dilemmas threaten the long-term growth prospects of the larger miners at one end of the sector and the short-term survival of cash-strapped juniors at the other end.

Margin protection, productivity improvement and resource nationalism round out the top three risks while the threat of substitutes is a new entry in the rankings, at number ten.

“The rising business risks that are the primary concern of mining and metals CEOs and boards currently are being driven by the need to protect returns and manage the interests of varied and often competing stakeholders,” he says, adding that 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.

Botha notes 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 shorter-term return horizon of new yield-focused shareholders in the sector.

He adds that the sluggish share price performances of the sector also shifted the focus to returns through dividends.
“Many years of high growth in earnings, cash flows and capital appreciation have attracted a different group of investors to mining. These investors have shorter-term investment horizons and are not as comfortable with the sector’s longer-term and often counter-cyclical development, investment and return horizon,” he says.

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

“This raises the question of balancing the demands of short-term shareholders with those investing in 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,” he says.

Fight for Survival
Botha states that the other end of the capital-dilemma spectrum comprises the cash-starved junior miners who are uncertain about their survival.

“The dramatic and continuing sell-off in equity markets has starved the junior-miner end of the market of capital. Advanced juniors and midtier producers have been caught in the middle, exposed to a fragile balancing act between investors’ thirst for yield and a low tolerance of risk,” he says.

Botha points out that the cash and working-capital position of the industry’s smallest companies underline the severity of the situation.

He notes that other strategic business risks in the global mining and metals sector include social licences to operate, skills shortages, price and currency volatility, capital project execution, the sharing of benefits, infrastructure access and the threat of substitutes.

Protection and Productivity
“A decade of higher prices has concealed the impact of rampant cost inflation, falling productivity and poor capital discipline in the sector,” says Botha, adding that the softening of commodity prices in 2012, the legacy of the growth-at-any-cost phase of the super cycle and rising costs created a perfect storm to squeeze margins and drive down profitability.

“As a result, margin protection and productivity improvement have jumped to number two in the risk rankings,” he says.
Botha notes that, while some of the factors squeezing margins – including scarcity premiums for inputs or high producer currencies – will ultimately self-correct as mineral prices fall, companies still need to address operating costs and capital allocation.

“Productivity in the sector has been on the decline for nearly a decade across labour, equipment, processes and logistics.
“Those who have tackled costs early are now focusing on improving productivity through using labour, equipment and innovation more judiciously as a means of enhancing productivity,” he states.

Resource Nationalism
Resource nationalism remains prolific worldwide and continues to be a critical issue for mining and metals companies.
Botha says taxes and royalties, mandated beneficiation, government ownership and the restriction of exports continue to increase worldwide.

“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 result in governments taking 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,” says Botha.

Social Licence
Botha notes that social licence to operate has consistently ranked between four and six in the risk rankings.
“Community and environment activists have become more vocal and powerful through social media about climate change, the competition for water and the impact mining has on communities,” he states.

Botha adds that the rate at which new challenges arise continues to accelerate and that antimining sentiment continues to proliferate against a backdrop of community and climate change concerns.

“As with resource nationalism, the key to achieving and maintaining social licence to operate lies in better communicating the shared value of mining projects with local communities and other stakeholders,” he says.

Skills Shortage
“Skills shortage slips to five on the list, as the deferral or cancellation of new projects brings temporary relief, but staffing the massive current development pipeline still remains an issue,” he says.

He points out that, in addressing the skills shortage challenge, companies must continue to adopt creative and innovative approaches to access new pools of talent and leverage technology, as well as motivate, engage and retain the existing skilled workers.

Sharing the Benefits

“Sharing the benefits has moved up one place in the rankings as stakeholders increase their call for a bigger slice of the pie, despite lower margins. While stakeholder demands will naturally rebalance over time, those companies that communicate with their stakeholders to bring that rebalancing forward will create greater value,” says Botha.

He adds that stakeholder demands and needs differ, depending on the group and their associated drivers and demands.

“These groups typically include governments, communities, shareholders, employees, suppliers and downstream industries. Under- standing their differences and managing these accordingly will secure the best outcome for all,” he concludes.

Threat of Substitutes
The shale gas boom, in the US, and the gas-for-coal substitution, in North America, have highlighted the very credible and looming threat of substituting single-commodity companies, or companies where one commodity dominates the product mix or profit share.

Botha says that the threat of substitution has been transformational for the US coal market, with global ramifications. For other commodities, it has the capacity to radically and rapidly change their market, should the right conditions prevail.

Other examples of this threat include aluminium for steel; palladium for platinum; aluminium, plastics, fibre optics or steel and graphen for copper, and pig iron for pure nickel.

Substitution affects some commodities and some countries more than others, through regulatory changes, commodity-cost or supply issues, products with low profit margins and less dependence on quality and performance, environmental concerns and technology advances.

For South Africa, the warning bells are sounding to diversify its commodity mix and to monitor interdependent sectors.

“Once substitution starts occurring, it is potentially irreversible, as it could cause a structural shift in consumer habits,” concludes Botha.