PERTH (miningweekly.com) – The mining industry would remain under pressure from unprecedented price and currency volatility for the next few years, as the sector approached demand/supply equilibrium, advisory firm Ernst & Young (E&Y) reported on Friday.

In a white paper released to the market, E&Y noted that demand for most commodities had outstripped supply for the best part of the past decade, fuelling higher prices and encouraging new supply.

It noted that, as supply and demand now approached equilibrium, longer lead times in changing supply were leading to over- and under-corrections in supply, leading to greater price volatility.

E&Y global mining and metals leader Mike Elliott said on Friday that the more progressive mining and metals companies were finding new ways to manage this volatility that would deliver benefits throughout the next two to three years, when sharper and more frequent movements in prices were expected.

He added that industry players would be preoccupied with reacting to the downside risk of price and currency volatility in 2013 and 2014.

Recent price volatility was underlined by the December 2012 reported results of the large diversified mining companies, in which mineral price movements accounted for 79% of the $25.6-billion fall in the period-on-period earnings.

“The knee-jerk reaction is to begin hedging again. However, for most, the opportunity to establish an effective hedge has passed and those that are enticed to enter into significant hedging during this period of volatility may create problems for themselves during the next upswing,” said Elliott.

He added that several miners might use put options to manage short-term price risk; however, these were increasingly expensive and companies needed to look at ongoing solutions to manage the risk through the shorter price cycles.

“Mining companies that can build flexibility into their business to respond to short-term volatility, can create a competitive advantage. The sophisticated modelling tools available now mean that miners can consider multiple scenarios to identify how and where volatility impacts the business, and identify in advance possible actions to optimise their returns.”

Actions could include being nimble with changes to cutoff grades and mining sequencing, increasing the flexibility of costs to become less fixed and, therefore, more variable, and challenging notions of scale, Elliott said.

“Miners need to improve the integration of mine and financial planning and, importantly, increase the speed of mine planning to match volatility. Companies also need to do a better job of communicating to their shareholders the changes they are making to increase flexibility and what impact that may have on future margins. Without this, shareholders will expect the worst – that a company is unable to capture the price rises but is fully exposed to price falls.”

He added that investors, in turn, should be seeking to understand where value was being created through the introduction of greater flexibility in the companies they are investing in, because it will be a differentiator in bottom-line results.