Where do miners go from here?

The shift from “quantity to returns” has led to numerous headaches for miners, causing project delays, hefty writedowns and CEO departures, while companies tackle escalating costs that have caught up with the rising commodity prices, says Lee Hodgkinson, the national industry leader of KPMG’s Canadian mining practice.

KPMG is a global network of firms that offer audit, tax and advisory services for various industries, including the mining industry, where it also advises on strategy, growth, performance and compliance.  

Hodgkinson — a chartered accountant by training, who specializes in mining — says there has been a rise in commodity prices over the past decade that has been driven by urban population growth, which has fuelled the need for base metals. The weakening U.S. dollar has also bolstered the gold price, as countries buy more gold.

“This should have led to incredible returns for the companies and their shareholders, but instead, what we’ve seen is a separation between commodity and equity prices,” he said, while moderating KPMG’s panel at the Prospectors & Developers Association convention in March.

Exchange traded funds’ impact on gold stocks cannot be overlooked, he points out, as they provide an alternative to risks — including development, political and management risks — that come with shares in mining companies. 

There’s also a general decline in mine reserves, which pushes up operating costs while organizations build larger, more capital-intensive projects to mine lower grades, he notes.

It’s only recently that many firms have steered away from growth to focus on returns, as commodity prices level off and capital markets dry up, Hodgkinson says, noting that investors are punishing companies with big pipelines. In response, companies are tightening their purse strings and halting capital-demanding projects. “Is this a good strategy?” he asked KPMG’s advisory panel, which included Brad Watson, Augusto Patmore, Simon Beer and David Waldron.

With the tight capital markets, miners are putting the brakes on production growth, and maybe stopping some of their projects and focusing on operations, Waldron says, who is a management consultant. He concedes this is a good strategy, but says that companies should consider trade-off studies before curtailing their pipelines.

“The acid test here is: Do these projects improve your financial position that your company is going to have in generating results? Can you swap smaller projects for the bigger ones you’ve announced before? Can you consider situations where you would open the pipeline in favour of dialing back on some of your current operations? Could you think of a situation where the new project is going to generate better cash results than your past operations? These are some trade-offs you can do,” Waldron says, whose areas of expertise include business strategy and planning.  

He adds that the market will likely stop punishing companies that deliver on their story and promises.

Cost drivers

Patmore — an engineer by trade, who has managed large infrastructure and mining-capital projects for 17 years — identifies three issues that are driving up costs for mining projects.

The first involves inadequate risk-transfer mechanisms that are built into contracts. “We see a trend of large mining companies hiring EPCM firms to manage their design-build process and billing their whole responsibility to the EPCM, but the risk the mining company is taking in executing that project is not transferred to the EPCM firm,” he says, proposing that to reduce unexpected costs, the risk should match the responsibilities of all the parties involved in the project. He says that incentives, bonuses, commissions, wrap-ups and contract close-outs should be properly analyzed and written in contracts.

Secondly, scope changes in a project caused by designs that are not complete or advanced enough often result in higher costs. 

For underground projects he points out that the most common pitfall pushing up costs is an inadequate description of ground types because not enough bore holes were made before designing a mine plan, leading to errors in budgeting, forecasting and estimating workforce. 

After stressing the importance of early planning to define a project, he says that companies should consider where and how to source their equipment, supplies and workforce.

He points out that firms in developing nations — such as Chile, for example — hired a few skilled international expatriates early on, and often reported better productivity.

“Bringing two to three people out of the fifteen- to twenty-person team from abroad — but having those key people in at the early stages — really increases your productivity. It may look like a high and unnecessary cost in the beginning, but believe me, it’s not. People need to know what they are doing and people need proper training, and after that, you can train the locals.”

For equipment, some countries may force firms to nationalize the equipment. This is something companies should consider, as it will add to the tab, Patmore says. Firms should realize that some jurisdictions may have long-lead times and limited suppliers, he explains, making it difficult to buy supplies within budget.

“You might get a rebar order in Canada to a construction site in a week, but in Peru, it might take fifty to sixty days. That’s just how things work down there . . . you need to know that and build it in your budget.”

Patmore concludes that most of these issues can be mitigated by investing more time in early stage planning.

“A little bit of strategic project-execution planning in the beginning is what makes all these things right, and what gets your companies in position to have proper contracts, proper suppliers and the right amount of people working as they should,” he says.

Infrastructure needs

The need for infrastructure is affecting mining companies now more than ever before, Watson says, who heads KPMG’s global infrastructure advisory practice in Canada. He points out that companies need a different skill set to develop infrastructure so that they can ensure everything is delivered on time and on budget.

He suggests that firms should “plagiarize liberally” when it comes to developing infrastructure, such as roads, power plants and rails. For example, he says that when building access roads, firms could look at existing contracts that the local government has for roads, which would include the terms and conditions for hiring a contractor to perform the work, along with the technical provisions and standards.

Similar to the previous speakers, he underlined the importance of integrated planning when companies are in the early stages, noting that once firms tack on all the infrastructure requirements to a mining project, the complexity grows exponentially.  

“Putting a little bit of effort upfront and having a little bit more dialogue initially around the critical path and seeing how the various pieces hang together is critical when you talk about a project that is as much an infrastructure project as it is a mining project,” he says, noting that while there’s a trend for companies to develop infrastructure, there is also an independent trend of institutional investors looking for infrastructure investments around the world, creating an opportunity for mining firms to work with an institutional investor to monetize a piece of infrastructure.

Watson points out that common problems companies face when it comes to developing infrastructure include poor definition of project scope and not understanding the needs and concerns of the local government around infrastructure.

“It i
s never good press if you are running power lines over dark communities and there is not going to be electricity in those communities. You have to think of these things,” Waldron says. The infrastructure companies built on a community’s social side are important in sustaining relations, he adds.

Improving performance

Beer, who specializes in operation strategies and costs reduction, says that the move from volume to value has been difficult for companies, as cost escalations were initially masked by higher commodity prices.

Focusing on cost-reducing initiatives has been hard, but there are some organizations that have reduced costs without harming their production volumes, he says. 

“The key factor for me in all of this is taking an objective, dispassionate view of costs, and ensuring you get complete transparency across the entire life cycle, and can identity the specific actions that could really drive some changes in that area,” he says, adding that there are several areas companies can target. One of his mining clients in South Africa, for example, reduced its cost structure 25% by focusing on labour productivity, energy use and integrated mine-process planning.

Companies should examine what their staff are doing and what activities are driving up costs, and go through these activities to see how they can be done differently to boost productivity, Beer says. He points out that when looking at blasting strategies, some companies get better results by moving to water-gel explosives.

For energy, he says companies could benefit from understanding when and why they need energy, and align their needs to low-tariff periods, especially in developing nations. Beer adds that even better results could be achieved if companies do this while using energy-efficient equipment.

Moving to integrated mine and process planning, he points out that firms should grasp the full value chain of activities — from mining, concentrating, smelting and refining — to identify cost savings.

Beer concludes that if companies could prevent “stoppages, blockages, backups and shortages” in their value chain, it could drive changes in performance.  

‘Selecting away’

Before going through cost-containment exercises, firms could reduce their troubles by “selecting away from projects,” Waldron says, adding that this is “as important in containing your headaches as selecting projects that you are going to do.”

Waldron says that companies should also plan on how to deal with possible scenarios, such as resource nationalism.

“You want to avoid the headaches, so go ahead,” he says. “Understand your risks, and understand what you are capable of accepting. Make sure when you select your projects that you are cognizant of what you choose not to do, and simply don’t do it. Finally, when you are planning, plan in scenarios, get on that path and know where the exit ramps are, just in case you do have to exit.”