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The Year’s Top Priorities for Mining CEOs

December 31, 2012 Comments off

With rapidly increasing production costs, metal and coal prices stable or decreasing, and general global market uncertainty, 2012 was not an easy year to be the CEO of a mining company. The boards of many mining companies have drawn their conclusions and decided 2013 will be the year in which a new leader will make a start. These new executives and the veterans that survived 2012 will face many similar challenges in the new year. The market for project development appears to cool down, but cost pressures and decreasing margins are real and volatility is here to stay for some time.

Below 7 key priorities for mining CEOs in the coming year:

1. Watch your balance sheet

Global debt problems aren’t over yet, and a company’s debt is never stronger than the host country’s sovereign debt. A lot of national, regional, and corporate debt is still overvalued. The European financial system being too young to make tough decisions, the American political system being to antique and entangled in corporate interests to make tough decisions, and a new Chinese government being too dependent on international markets and national stability to make tough decisions are not going to help to solve the debt issue anytime soon. A new chapter of the debt crisis is likely start in 2013, creating a volatile environment in which prudent balance sheet management is key for business stability, preventing you from finding yourself standing at the edge of a solvency cliff, as many coal miners and even iron ore miner Fortescue experienced recently. Don’t get deep into debt, and don’t wait ‘till the last moment to refinance maturing debt, as many global developments could make raising money in debt markets suddenly very hard.

2. Kill bad projects

As a result of rapidly increasing product prices and in the knowledge that global demand for most commodities continues to grow over the next 2 decades, the project pipelines across the industry have been filled to the max. However, for most products only about one third of the projects currently being communicated as ‘planned’ is actually needed to bridge the supply-demand gap in the 2025. That means two out of three projects need to be stopped. And yes, that includes some of your projects. Deciding which of the development projects in the global industry actually are the good projects, and which not so good projects do have a chance to succeed simply because they have a powerful developer, is going to be a key task for this year. Simply doing an IRR calculation based on an imaginary product price doesn’t do the trick; there might be plenty of better projects out there that will make your price forecasts miss the mark completely. It’s time to rev up the intelligence on competitor’s projects: in the end the best projects survive. Making sure you get hold of your fair share of good projects is the objective for the coming years. Those projects that don’t pass the test and that happen to be yours? Kill them, and move on to priority number 3.

3. Expedite good projects

Hopefully your assessment of global project potential confirms your view that some of the projects in your pipeline will make the cut. Now do everything you can to bring those projects forward. Counter-cyclical investment has been a mantra of management gurus forever, but very few executives actually dare to execute on it. Redirect the resources you free up by killing bad projects – finances, human capital, and equipment – to those projects that might succeed. This does not only help you to bring those projects forward, it also sends a clear signal to the market that those projects really are the probable survivors of the battle of the fittest projects. If you decided that none of your projects are good enough to make it? Get to work on priority number 4.

4. Buy cheap future growth

Many of the important mines of the end of this decade and of the coming decades are still in the hands of explorers or juniors that don’t have the funds or appetite to develop the projects, that are always on the outlook for the acquirer, and that have seen their share price become much more discounted than the prices of their potential acquirers. Buying current production is expensive as always and will be tough on your balance sheet, but this year is not a bad moment to buy the exploration-stage projects that will make your company great in the long run. Be aware that for many of these projects the development capital, that scares most company executives at this point, will actually only be needed during the next commodity price cycle. And yes, those projects are challenged geographically, politically, technically, and environmentally, but so were most of the current great mines 10 years before they started producing.

5. Be tough on suppliers and contractors

The slump for mining suppliers and contractors lags the slump for miners by about a year. Last year was the moment of the great awakening in mining companies that the period of rapid growth is over; this year their suppliers and contractors will feel the pain. Don’t forget to squeeze your suppliers out this year! With many projects being shelved or stopped the bargaining position of engineering and construction constructors and equipment manufacturers is deteriorating quickly. Over the past years they have enjoyed a situation in which there were simply not enough skilled people and production capacity to serve all of the industry’s wants straight away, but that period is about to be over. Cost pressures are still there, but the mining companies can solve part of that issue by paying less in new procurement and trying to renegotiate existing contracts.

6. Get talent on board when the job market is down

The suddenly emerging reality of thinning margins has made most mining companies very hesitant in recruiting, and has led several companies to reduce the size of the workforce or implement hiring freezes. The job market in the industry does not look good, so people stay where they are. Just as you should be searching for the right projects especially during tough times, you should be on the hunt for ambitious talent when the job market is bad. Good people always want to make the next step, and any period in which making steps is hard is a headhunter’s bonanza. Not only half of Xstrata’s executives is seriously looking for a new challenge away from Glenstrata, but junior, mid-management, and executives in paralyzed companies around the world are sensitive to a good offer at this time.

7. Prepare for the low/now growth era

Most of the young talent you recruit at this point will witness the age of ‘peak mining’ during their career. Riding the wave of development in emerging countries the mining industry’s output will grow over the next decades. Still, driven by demographics, economics, and increasing recycled metal supply, the demand for most mined metals is likely to start a slow decrease around 2040. Your investors don’t really care about anything that happens after 2020, but the talent you are recruiting and the communities you are operating in do care. Rio Tinto’s ‘Mine of the Future’ program is focused entirely on the technological future of mining. However, preparing your company for a new, low or no growth, normal implies exploring a whole new way of doing business, technology only being a minor part. Wouldn’t it be great to be known as the CEO who prepared the company for ‘Mining of the Future’?

Enough to work on to keep the miner’s job interesting in the new year! Do you happen not to be the CEO of your company? Don’t hesitate to forward this text to him/her to make sure the most important to-do list in the company includes these priorities. Happy new year!

2012 | Wilfred Visser | thebusinessofmining.com

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Glencore should scale back IPO hopes

May 5, 2011 Comments off

“For Glencore International, it is time for Plan C. Xstrata put the kibosh on Plan A when it refused to consider a merger with the commodities-trading giant that would have enabled Glencore partners to realize the full value of their 34.5% stake in the miner.

Investors now have ruined Plan B by refusing to accept Glencore’s ambitious $60 billion-plus valuation target, which might have allowed a quick post-IPO merger. Glencore has been forced to lower its target and must prepare for a long spell in the public markets.

Glencore’s advisers insist Mr. Glasenberg realizes the need for a realistic price that will allow it to trade healthily in the aftermarket. That would help rebuild investor confidence after the poor start to the IPO. So Glencore’s final IPO price will need to offer investors a generous discount. Mr. Glasenberg should brace himself for a price at the bottom of the range.”

Source: Wall Street Journal, May 5 2011

Observations:

  • The commentators from Wall Street Journal argue that the uncertainty of a potential merger with Xstrata and the politically sensitive nature of Glencore’s mining assets forces the company to offer the shares at a strong discount in the Initial Public Offering (IPO), raising less cash than previously hoped.
  • Glencore is going public to facilitate further growth ambitions. In its current private structure it can not raise sufficient money for further growth. Merging with Xstrata would be an other way to solve this problem, but this requires putting a value on Glencore to decide on the new ownership structure, something Xstrata’s management and shareholders clearly are not willing to do.

Implications:

  • Shares are typically sold at a discount in an IPO, encouraging investors to take a share of the company and realize a paper profit in the first days of trading. However, if shares indeed go up strongly in the first days of trading and market value of Glencore reflects intrinsic value correctly, the WSJ-commentators’ prediction of a difficult negotiation with Xstrata because of skewed valuation does not hold.
  • With current high commodity prices a large part of Glencore’s profit comes from its industrial assets, rather than from trading activities. Citi expects the industrial share to be as high as 60% in the next years. A relatively higher importance of production vs. trading in the company could make integration of Glencore with Xstrata and/or other mining companies smoother.

©2011 | Wilfred Visser | thebusinessofmining.com

Oliver Wyman: Commodities bubble

February 15, 2011 Comments off

2015: Based on favorable demographic trends and continued liberalization, the growth story for emerging markets was accepted by almost everyone. However, much of the economic activity in these markets was buoyed by cheap money being pumped into the system by Western central banks. Commodities prices had acted as a sponge to soak up the excess global money supply, and commodities-rich emerging economies such as Brazil and Russia were the main beneficiaries. High commodities prices created strong incentives for these emerging economies to launch expensive development projects to dig more commodities out of the ground, creating a massive oversupply of commodities relative to the demand coming from the real economy. In the same way that over-valued property prices in the US had allowed people to go on debt-fueled spending sprees, the governments of commodities-rich economies started spending beyond their means. They fell into the familiar trap of borrowing from foreign investors to finance huge development projects justified by unrealistic valuations.

Once the Chinese economy began to slow, investors quickly realized that the demand for commodities was unsustainable. Combined with the massive oversupply that had built up during the boom, this led to a collapse of commodities prices. Having borrowed to finance expensive development projects, the commodities-rich countries in Latin America and Africa and some of the world’s leading mining companies were suddenly the focus of a new debt crisis. In the same way that the sub-prime crisis led to a plethora of half-completed real estate development projects in the US, Ireland and Spain, the commodities crisis of 2013 left many expensive commodity exploration projects unfinished.”

Source: Oliver Wyman: The Financial Crisis of 2015, February 2011

Observations:

  • Oliver Wyman, the international consulting firm, recently published a report in which it describes ‘the avoidable history’ of the next financial crisis. It foresees a bubble of commodity prices, caused by cheap money supply to developing countries in reaction to increased regulation in the developed world.
  • Wyman lists a number of prevention measures that should help to prevent the scenario sketched above from happening, removal of subsidies and scenario planning for development decisions being the most applicable to the mining sector.

Implications:

  • The factors Wyman does not include in its analysis are the long development lag of natural resources projects, causing supply to trail demand changes by several years, and competitive dynamics in the industry. Both factors might eventually strenghten the effects described, but a burst 2015 might be a too aggressive timeline.
  • Careful analysis of the sustainability of demand growth in Asia, in particular in China, is crucial for the investment decisions for long term projects in all mining firms, not only the companies that have Chinese customers. Once Chinese demand slows down the global fulfillment dynamics will change, making the low cost suppliers (totalling production and transportation costs) survive.

©2011 | Wilfred Visser | thebusinessofmining.com

Not all Chinese Cash Boosts Commodities

June 3, 2010 Comments off

“It is rarely a good idea to become overly reliant on one customer. Especially when that customer is trying to build a rival supply business of its own. China accounts for 36% or more of global demand for metals like copper, aluminum and zinc, according to Barclays Capital…

One big risk with a key customer is that its appetite wanes. Another, less obvious one, when it comes to China is its effect on the supply side.

China’s approach to dealing with its shortages of raw materials is ‘to throw money at it,’ says Jennifer Richmond at Stratfor, a global intelligence firm. Chinese firms have spent $79.6 billion acquiring foreign natural-resources producers since the start of 2008, according to Dealogic. Meanwhile, Beijing has struck deals from Russia to Africa offering loans and infrastructure development in exchange for minerals.”

Source: The Wall Street Journal, June 2 2010

Observations:

  • Using various investment funds, banks and state-controlled companies, China has invested in building production capacity across the world. Not only in Africa, but also in Australia and Asia the Chinese are building a supply foothold.
  • WSJ’s Denning argues that the increase of production capacity caused by the Chinese investments will eventually lead to overcapacity and thus to decreasing commodity prices.

Implications:

  • The potential oversupply created by Chinese investments is certainly a long term issue. Most investments in the mining industry do not lead to output in a period shorter than 5 years. Many things can happen to the demand in that period.
  • Apart from the need to build capacity to satisfy the demand increase, the surge in investments in exotic places is driven by the decreasing ore quality of the average new mine. Companies need to mine lower grade ores in more extreme places. As the investment required per ton of output increases, the investments will not necessarily increase supply at the same levels as demand. As long as China grows at 10% per year, it is going to be very hard to keep up in terms of production.

©2010 – thebusinessofmining.com

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