For thousands of years the mining industry has supplied the world with the raw materials the growing population needed for ever increasing consumption. However, mining is not the only supplier of these raw materials. Next to the primary mining industry a secondary mining industry is growing: ‘urban mining’. The existing stock of materials in the urban environment is recycled more and more. 38% of iron input in the steel making process comes from scrap. The average ‘new’ copper cable contains some 30% recycled material. The more we recycle, the less we need to mine. As mining costs increase because ‘easy’ mineral deposits are becoming scarcer and as technological improvements make recycling more competitive, the impact of urban mining on the traditional mining sector grows. How does this change the perspectives of the mining industry in the long term? And which factors will play an important role in shaping this future?
Chalco (holding company = Chinalco) made a tentative $930mln offer for 57.4% ownership of SouthGobi Resources, a Canadian listed company, currently owned by Ivanhoe resources.
BMA, the coal JV between Mitsubishi and BHP Billiton in Queensland, declared force majeure after a week long strike in some of its mines. The labor conflict has been going on for almost a year, with workers campaigning for better contract rights for contracted workers and to retain the union’s power in recruiting decisions.
Alcoa, the largest aluminium producer in North America, announced it would cut alumina production by 2% to support prices.
At the start of the year Alcoa cut aluminum production, at that time by 12% and mainly in the USA. The 2% alumina cut is said to be aligned with this 12% ‘final product’ cut.
The potential Chalco – SouthGobi deal appears to be engineered by or via Rio Tinto. Chinalco owns a significant stake of Rio Tinto, which became the majority shareholder of Ivanhoe recently with the key objective of quickly developing the Oyu Tolgoi gold-copper mine (also in Mongolia).
Despite a general demand boom which has not passed aluminum many major aluminum producers are posting losses. Profit margins over the past 10 years average below 10%. The key reason for this situation is an overcapacity resulting in oversupply and high inventory levels. Aluminium is currently one of the very few mined natural resources that could be seen as a ‘demand-driven’ market rather than a ‘supply-driven’ market for price setting. However, as more and more producers cut investment, the demand growth fundamentals should invert this situation in the next couple of years.
Alcoa's long term demand outlook as presented end of 2011
Rio Tinto invests over $0.5bln on driverless trains
Rio Tinto announced a large investment in its ‘Mine of the Future’ program to make the first of its approx. 150 trains on the Pilbara iron ore network driverless by 2014. The program will cost the company over $500mln, though it remains unclear what part of that amount is ‘research’ and what part is plain ‘hardware’.
Kazakhmys, the Kazakh copper miner, posted flat profits as growth was offset by cost increase of over 20%, mainly due to skyrocketing labour costs in the country’s resource market. The company also made bullish statements about growth of the copper demand in China.
Driverless trains are only one step in the larger automation effort for which Rio Tinto is the technology leader. Other areas of research are improving exploration performance and increasing recovery, especially from underground mines. A lot of the automation work focuses on the iron ore operations in Northern Australia. These operations have the scale to enable large savings by automation, and they struggle continuously with finding sufficient skilled employees at acceptable costs.
Whether or not Rio Tinto’s role as the ‘technology leader‘ is a smart strategy is debatable: one might argue that begin a ‘smart follower‘, and thus not paying for the disappointments any large-scale research program holds, is more cost-effective. However, Rio Tinto has taken the approach that any research that can pay for itself in the long term is worth doing. Clearly the company will try to protect its findings as much as possible, but other companies will certainly start using its innovations in some way, reducing demand for skilled labor in remote positions and improving recovery potential.
Conflict arose in the board of Bumi, the Indonesian coal miner with the investor Nathan Rothschild as a large investor after a reverse takeover of the Vallar investment vehicle. After initial conflicts the Indonesian board members planned to remove mr. Rothschild from the board, but he now only appears to have to give up his co-chairmanship. Share price of the company dropped significantly after the news of the conflict.
(Higher prices + higher costs) x lower volumes = lower profits. That was the story of the results releases of the world’s largest miners this week. The impairment taken by Rio Tinto on the Alcan acquisition costs probably was the most significant item, together with the relatively positive outlook given after the negative and uncertain signals given about global demand in the past months.
BHP (58%) and Rio (30%) expand Escondida at $4.5bln cost
BHP Billiton and Rio Tinto announced investments of $4.5bln to replace the plant at Escondida, the world’s largest copper mine in output, increasing capacity and enabling mining restricted by the current facilities.
February is the month in which most of the world’s largest diversified miners present their annual results (only BHP Billiton runs a different fiscal year). The investor presentations provide interesting reading and give a good idea of the vision for the future of the industry. Below a peak preview with the most insightful slides from the presentations:
Anglo American – Price benefit achieved mainly in first half of year
Rio Tinto – 2011 in Summary: high prices are the only good news
BHP Billiton – Cost pressure is high, but not structural
Rio Tinto – Borrowing to pay out next to all investments
Anglo American – restarting the diversification discussion
Xstrata – Supply constraints lead to the Glencore merger
For several years Xstrata and Glencore, with over 30% its largest shareholder, have been linked in rumors of mergers. This week both companies released statements to announce that Glencore has now officially started the merger procedure. As a result Glencore is required to come up with an official proposal by early March. However, analysts expect an agreement to be reached much faster.
Glencore is the world’s largest commodity trader and also owns operating assets for several commodities, most notably copper, zinc, and coal.
Xstrata is the world’s 4th-largest diversified miner, grown rapidly in the past decade by a series of acquisitions.
Last year Glencore became a public company, putting an official market value on the company. This step was seen as a requirement to convince Xstrata’s other shareholders to discuss a merger.
Why does a merger make sense?
Although the mining industry only very slowly moves in this direction it makes sense to combine raw material production and marketing and processed goods production and marketing in one company. The vertical control over the value chain provides flexibility to react to sudden opportunities in the global marketplace. The 3 pictures below illustrate Glencore’s view of these arbitrage opportunities: geographical, product, and timing arbitrage. The larger the company is and the more overlap between marketing and production, the larger the rationale for merging. Estimated synergies of the Glencore-Xstrata merger are close to $1bln annually, mainly due to increased revenues (whereas most mining related M&A is driven by cost reducing synergies).
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What could go wrong?
Two important things could make the merger fail. The first could even prevent it from happening at all:
1. Antitrust - Glencore is the absolute market leader in trading of various commodities. Any increase of power in these areas would trigger action by antitrust regulators around the world. To get approved, the deal will have to be structured in a way that ensures both supply substitution and demand substitution; i.e. all market parties should be able to get around Glencore-Xstrata as customer or as supplier.
2. Corporate culture - Glencore is a company built on the two-thousand marketeers & traders, while Xstrata is run like a typical conservative mining company. Traders are typically very smart, aggressive, impatient, rational, office-workers. Miners are ‘roll up your sleeves’, ‘move the dirt’, operational guys with only very few of the highly schooled trading-types among them. To make these two groups of people not only work together smoothly, but to integrate the companies so that departmental interests and emotions are fully aligned with the larger companies objectives is going to be a major challenge, in which many employees from both sides might choose to leave the company to find a place where they are more comfortable.
Vale announced its plans to appeal to the governments intent to charge $5.6bln worth of taxes on foreign earnings. The clash with the government promises to be the first real test for the new CEO Murilo Ferreira.
Mr. Ferreira took over the leadership of the company from Roger Agnelli, who was not reelected partly based on a disagreement with the government (which is control Vale via state-controlled shareholders) over $2bln taxation.
Rio Tinto increased its ownership of Ivanhoe from 49% to 51%, giving it full control over the flagship Oyu Tolgoi copper project in Mongolia, the world’s premier copper development project.
Vale estimates the impact of a review of the tax code on the company’s earnings to be approx. 4-5% of earnings. Taxation regimes around the world for specifically iron ore and copper mining are reviewed to make the countries benefit more from ‘extreme’ profits, which could be seen as a temporary phenomenon. However, the key issue in Vale is facing now is a debate about double taxation; paying taxes over profits after taxes realized in countries where the company is operating.
Rio Tinto’s control over Ivanhoe will help the company to put in place its management structure and have the project managed by some of its top project developers. Gaining full control of the project in this stage will help Rio Tinto to build the project according to the company’s standards, preventing costly and above all time-consuming future transitions in the operating structure. The global standards that enable effective project management more and more set the world’s largest miners apart from the ‘small’ mining firms with only a few operating assets. Very much like GE has become known as a great ‘project management company’, the world’s largest miners are more and more developing into ‘mine development’ companies in which development speed is the key success factor and navigating politics in developing countries is a key skill.
ENRC agreed to pay $1.25bln to First Quantum to settle the dispute over the Kolwezi Tailings project, the Frontier and Lonshi mines and related exploration interests in DRC. First Quantum was stripped of the rights to these projects by the government, after which ENRC came in and agreed to buy the rights from the government in a move widely criticized in the industry.
Coal India, by far the largest miner of energy coal in the country, has agree to a 25% permanent increase of wages. In august of last year the unions demanded a 100% increase to offset increased cost of living and reduce the increasing income gap between management and workers. Investment bankers at the time expected the company to agree to a 15-20% increase. The salary hike results in an increase of operating cost for the company by approx. 10%.
Weather in Australia and Brazil drives iron ore price up
The closure of the export facilities in Port Hedland because of cyclone Heidi and the cancellation of shipments from Brazil because of heavy rains results in supply pressure in the iron ore market. Heavy rains are expected to continue in the Pilbara region, which supplies close to 40% of seaborne iron ore in the world, in the short term.
Extreme weather conditions have a big influence on bulk material supply chains in the short term, because stockpiling these materials in amounts large enough to last for several weeks is very costly and thus not a normal practice. Especially the steel industry is hit hard with both iron ore and metallurgical coal having to be shipped in from locations that are often hit by storms. Although the impact on spot prices in the short term can be large, the longer term impact on the miners is quite small. Most contracts allow for some flexibility in when exactly the ore is delivered. As long as the mining operations don’t have to stop, the ore will get to the steel manufacturers as some point.
The wage increase expected for Coal India is a good example of the very high cost inflation of mining in developing countries. Whereas the cost increase of contracted services and equipment leasing can be seen as (at least partly) a temporary phenomenon caused by high commodity prices, the cost increase because of increased labor and consumable costs in developing countries causes a more permanent shift of the global cost curves.
Australia solicits Chinese infrastructure investment
The government of Western Australia is trying to speed up the development of port and rail facilities of the Mid West region’s Oakajee port by stripping the Mitsubishi/Murchison combination of exclusive development rights and inviting Chinese parties to step in. 8 of the 14 projects in development in the region have Chinese investors.
Yanzhou’s Australian coal company Yancoal will merge with Gloucester coal, 64.5% owned by Singapore-based Noble group. As a result Yancoal obtains a listing on the Australian stock exchange, a condition put on the 2009 acquisition of Felix Resources
Anglo American launched a range of claims in Chilean court trying to prevent Codelco from being awarded the right to buy a full 49% of the Minas Sur assets. The scope of the option for Codelco to buy 49% has been unclear since Anglo sold a 24.5% stake to Mitsubishi. In response to Anglo’s claims Codelco restated its intention to acquire 49% of the full project.
As expected Chinese investments have proven to be a key driver of M&A activity in the mining industry in 2011. It is noteworthy that many Chinese firms are using a foreign based subsidiary or team up with a Western firm to do foreign investments. This structure holds 2 main benefits for the Chinese investors: they obtain an experienced western staff with knowledge of the way of doing business in the target countries; and they are viewed much more favorably by regulators when trying to execute deals.
The fight of Anglo American and Codelco over Minas Sur appears to become a long term court fight. The longer this court fight stretches, the more inclined Anglo American will be to find a compromising deal, as the uncertainty about the ownership structure will delay all investment decisions for the company in the mining region.
Freeport reached a two year extension of the collective labor agreement at its Indonesian Grasberg mine after a 3-month strike. The new agreement holds a 40% wage increase over 2 years, improved benefits, and the promise to base wage future negotiations on cost of living and competitor benchmarks.
Only days after the announcement of the agreement a helicopter transporting Freeport’s workers was shot at close to the mine, wounding one person.
Less than a year after being put up for sale and then declining all offers made Whitehaven teamed up with Aston Resources to create the largest listed coal mining company in Australia with $5.1bln market value. The deal is structured as a shares only acquisition of Aston by Whitehaven.
The South African court ruled that the department of mines had no right to grant the mining rights of Sishen iron ore mine in the country to a junior mining company with strong ties to some influential politicians, but that instead the Kumba Iron Ore holds the rights to the mine. Kumba is majority owned by Anglo American.
The coal mining industry in Australia is still relatively fragmented, with both the diversified supermajors and many domestic listed and unlisted companies active in the industry. Because the mining districts are much less concentrated than the iron ore or gold districts of the country it is harder to achieve economies of scale that would justify many mergers. The deals taken place are mainly based on transportation and sales negotiation synergies.
The Wall Street Journal published a good, readable, article this week describing the developments in the mining industry, signaling the combination of two key drivers this year: declining prices, and increasing costs. The resulting low margins will move the focus of many mining companies in the coming years to cost control. However, the winners of this cycle will be the companies that manage to invest during this period with lower profits to build capacity that will make them benefit from the structural increase in prices that will be caused by the structural price increases in the industry. Clearly not all cost increases are structural: equipment and contractor scarcity is mainly a temporary result of an overheated industry; but cost increases resulting from the move to harder forms of mining will stick.
After 5 years as CFO of the world’s largest miner Alex Vanselow (Brazilian national) announced he will step down and look for a CEO position in the industry. Mr. Vanselow managed to get BHP through the economic downturn in great financial shape (helped by high commodity prices). His recent experience in acquisitions of Chesapeake assets and Petrohawk and the failed acquisitions of Rio Tinto, Potashcorp, and the failed Pilbara JV with Rio Tinto, make him an interesting candidate for any resources company looking to grow by M&A.
In a legal fight over the rights to the Anglo American Sur project Anglo’s lawyers blame Codelco and the Chilean government to act unfairly. Codelco holds an option to buy 49% of the project, but it is unclear whether that is only of Anglo’s stake or of the total project.
BHP Billiton announced it will review its options around its only diamond project: Ekati diamond mine in arctic Canada. Rio Tinto, which owns the nearby Diavik diamond mine, is the most likely buyer because of the synergistic potential and the lack of funds and abundance of capital spending needs of other large diamond miners.
Mr. Vanselow will be an interesting candidate for global companies looking for a change of CEO. As Brazil’s Vale recently changed CEO and Petrobras’ Gabrielli de Azevedo is widely recognized as a strong CEO with work to do he will most likely look to head up a foreign player. The ideal period for a CEO is typically seen as 6-8 years: after that a new point of view and a new alignment with the personality needed for the phase of a company is often helpful. Taking a look at the top positions of the world’s largest miners at this moment, several CEO position changes can be expected over the coming years.
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