JOHANNESBURG (miningweekly.com) – If you under-invest in environmental impact, it will come back to bite you at some time in the future, just like cutting back on development used to do in the old days, former Eskom, Gencor, Billiton, Xstrata and X2 Resources mining doyen Sir Mick Davis said at the Joburg Indaba.
Davis said this in conversation with Rothschild & Co senior mining adviser Fiona Perrott-Humphrey after criticising the current dividend focus of mining majors, which was placing their companies on the road to share price decline through their lack of capital investment in value replacement: “Every single day that they take something out of the ground, that value disappears forever, and unless you do something to replace that value, you are going to end up withering and dying,” said Davis, who pointed to South Africa’s former Rand Mines as an example of no longer existing because of the absence of investment in rebuilding and recreating value. (Also watch attached Creamer Media video.)
Perrott-Humphrey’s response was that she is in total agreement with Davis on the gulf that has to be bridged between mining majors and investors on the dividends-ahead-of-capital-investment emphasis: “I totally agree with you, there is a fear at the board level now in big groups of having been accused of excess capital spend in the past, and this complete focus now on no capital spend.”
Perrott-Humphrey then went on to draw attention to cutbacks on environmental, social and governance (ESG) having a similar negative impact.
“There has also been the cutback, when paring costs, on things like ESG, which is why we’ve seen some of the disasters that have resulted. So, do you think part of the conversation also has to be, if you want us to do proper ESG, there is also a cost there and there is less coming through because of the dividend?” she asked.
“The answer to that is yes,” said Davis. “When you have the urgent need to cut costs, clearly the things that you cut generally impact you negatively in the long term.
“In the old days, the easiest way of improving your receipt from cut costs was to cut back on development, because you don't actually see the negative aspects of cutting back on development until maybe a year or so later – but you can have an immediate impact on costs.
“If you under-invest in environmental impact, and safety, and stuff like that, again, it comes back to bite you at some time in the future, so invariably those things require investment.
“But, you know, I’ve generally found that improvements in productivity and output go hand-in-hand with investments in these areas, so I don’t think that because you have the appropriate amount of energy of investment in things like ESG, and ensuring that your maintenance regimes are right and your development’s right, actually is an increase in costs, with no benefit,” Davis said.
“I actually think it goes hand-in-hand with improvements in productivity and I think you finally get that back. So, I don’t actually think that ultimately there’s a trade-off. I think you need to make the case for why you do it, but I think you gain almost immediate benefit, aside from the direct aspect of ensuring you’re not creating the risk by under-investing in those areas.
“But the bigger challenge is that, as you say, mining companies have always been accused of excessive investment and destroying capital, and it is true that that is what has happened, over many years.
“When you and I were starting out in this sector, you as an analyst and me as a young executive, we were right at the heart of the era when mining companies, controlled and dominated by engineers and geologists, were spending huge amounts of money, which was never ever going to be returned, and there certainly wasn’t going to be a return on that investment.
“And then we go through cycles, and then some of the accountants take over and they focus on return on investment, and things get better, but as demand goes up, and commodity prices go up and exceed long-term average prices, so people march into investing in capacity, and invariably, the people who get there at the back-end of that investment, ultimately spend the most amount of money, get the least return and end up in a difficult situation,” Davis said.
“So, that is all true, but it is very, very difficult for mining executives to calibrate those decisions with the precision that investors seem to want. You’re making decisions about investments which have a 20-, 25-year life, and the smallest change over that period in a variable – whether it’s your assumption on what your long-run price is going to be, or ultimately what elements contained in your seam of cash costs are – changes your returns dramatically. And it’s very difficult, once you’ve actually engaged that investment to actually step back and say okay, I’ll scale it down, and I‘ll either slow down the investment or alternatively, if I’m in operations, I’ll withdraw operations and not send as much product to the market place. That’s just not the way things work, and so you’re locked into an industry which is not able to calibrate with sufficient precision.
“So, the nature of the investor who invests in the mining industry has to recognise and respect cyclicality and has to recognise and respect the front-end loaded nature of your capex, and they should be interrogating not only the market decision as to why an investment was made but interrogate the resilience of those investments and the resilience of the balance sheet that supports those investments.
“So, I think there should be less concern about, we’ve built something, for some exogenous reason, the market falls away, so we have a period when we have low prices, lower than we thought we would have, because cycles will change and you will have much higher prices at some point in the future.
“What you have to test is whether you are resilient enough as an organisation to handle that investment and live with that investment through a period of unexpected low prices. And if that sense of resilience is what the market doesn’t test and the management don’t actually approach that well, that’s the area that management teams need to educate investors about and investors need to, in turn, go to management teams on their capacity to build the resilience.
“Then, you have to talk about if they are going to be building something, why has the industry so badly managed builds in the last few years. Why have we had these massive overruns. And I suspect that a lot of the reasons go to quite simple issues. We start these projects too soon in the development cycle. In other words, we start them without completing the engineering. There’s not enough engineering, there’s not enough measuring, it’s not sufficiently complete so we have to gerrymander the projects and change them, and that adds enormous costs into them.
“The other thing is that I don't think the industry understands fully that once the project is started on the ground, how to manage the sequencing of projects on the ground. Once people are on the ground, that cost is there every single hour of the day that they’re there, and if you have one thing that steps out of sequence, so you can’t productively deploy part of your construction force, then not only do you go over time, but you go massively over cost. And it’s those two areas which, I think, that we need to get right if we’re going to successfully build things in a way where we don’t have these massive overruns on time and our costs, which can never be recovered,” Davis said.
“Very spot on,” was Perrott-Humphrey’s response.