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Business risks facing

mining and metals


20122013

Contents

Organizations that succeed do so


because they are best able to optimize
the risk and reward equation for both
strategic and operational issues.
The Ernst & Young business risk radar for
mining and metals

Executive summary

The top 10 business risks

10

1. Resource nationalism

11

2. Skills shortage

14

3. Infrastructure access

17

4. Cost ination

20

5. Capital project execution

23

6. Social license to operate

26

Editorial Prospects and perils:


facing up to political risks in mining and metals

28

7. Price and currency volatility

32

8. Capital management and access

35

9. Sharing the benets

38

10. Fraud and corruption

40

Under the radar

42

Getting prepared

46

The Ernst & Young


business risk radar
for mining and metals

Up from 2011

Down from 2011

Same as 2011

New entry

The risks closest to the center of the radar are those that pose the greatest challenges to
the mining and metals sector in 2012 and into 2013.

The business risk report Mining and metals 20122013

Executive
summary

The business risk report Mining and metals 20122013

A more complex and extreme


risk environment
The bottom line is that if returns start to wane,
then there is a greater imperative for
organizations to tightly and more effectively
manage their risks to maintain an adequate
risk/reward balance.
Mike Elliott
Global Mining and Metals Leader, Ernst & Young

On the surface, the top ten risks dont look all that different
from last year, but below the surface there has been an absolute
shift that has made them signicantly different. The risks facing
the sector have become more extreme and more complex over
the past 12 months due to the fast changing investment and
operational environment. Two signicant contributing factors are:
1. Softening commodity prices which have seen mining and
metals companies taking on more risk relative to the short
term returns
2. Capacity changes in terms of skills and infrastructure which
have affected organizations short term commitment to capital
projects with life of mine of at least 10 years
Resource nationalism retains the number one risk ranking as governments seek to transfer
even more value from the mining and metals sector. Many governments around the world have
now gone beyond taxation in seeking a greater take from the sector, with a wave of
requirements introduced such as mandated beneciation, export levies and limits on foreign
ownership.
There is no doubt projects around the world have been deferred and delayed, and in some
cases investment withdrawn altogether, because of the degraded risk/reward equation. The
uncertainty and destruction of value caused by sudden changes in policy by the governments
of resource-rich nations cannot be understated. Mining and metals companies looking to
preserve value are actively negotiating value trade-offs with less politically sensitive policies
than resource nationalism. As this risk continues to grow in signicance, we dont expect a
slowing in this trend. Indeed, mining and metals companies must continue to engage with
governments to foster a greater understanding of the value a project brings to the host
government, to better communicate the implications of changes in the risk/reward equation,
and to more effectively negotiate appropriate trade-offs that preserve the value to both the
companies and the governments.

The business risk report Mining and metals 20122013

Global skills shortage and infrastructure access retained second and third spots on the risk
rankings this year. Both these risks are more acute in more locations now than they were
12 months ago, highlighting the supply capacity constraints that have hampered the sector
for some time. Rapidly escalating costs over the past year, where rising prices have not
covered this impact, have brought further challenges for mining and metals companies,
pushing cost ination up from number eight to four on our risk rankings.
Sharing the benets makes its debut at number nine this year. The relative prosperity of the
mining and metals sector at a time when many other sectors in the global economy are
struggling has seen this new risk emerge for mining and metals companies. Stakeholders
ranging from the government to employees, the local community and suppliers, feel they
are entitled to a greater proportion of value created by mining and metals companies. This
has forced companies to balance the expectations and the needs of their many
stakeholders. When they fail to do so, it results in strikes, supply disruptions, shareholder
activism and governments using their power to achieve their portion through resource
nationalism. Miners are willing to yield some returns on the appropriate transfer of risk to
stakeholders. However, many of the stakeholders, who want an increased share of the
mining and metals prots, are not taking on additional risk for their increased return,
leaving the mining and metals companies to carry all of the risk.
Rounding out the top 10 risks are cost ination, capital project execution, social license to
operate, price and currency volatility, capital management and access, and fraud and
corruption, with almost all of the top 10 risks more complex and more critical for mining
and metals companies now than they were last year.

Top ten risks over ve years


2008

2012

01

Skills shortage

01

Resource nationalism

02

Industry consolidation

02

Skills shortage

03

Infrastructure access

03

Infrastructure access

04

Maintaining a social license to operate

04

Cost ination

05

Climate change concerns

05

Capital project execution

06

Rising costs (cost ination)

06

Maintaining a social license to operate

07

Pipeline shrinkage

07

Price and currency volatility

08

Resource nationalism

08

Capital management and access

09

Access to secure energy

10

Increased regulation

new

Sharing the benets

10

Fraud and corruption

Remained in the top 10 over 5 years

So although we havent seen large changes in the ranking of risks year on year, the bigger
swings are evident over the medium term. Five of the risks have consistently remained
crucial risks over this period, while the remaining ve have fallen out of the top 10 table
altogether.
In a rising market, the returns have justied taking on more risk. While the demand outlook
remains strong, the price peaks have passed and so there is a much greater imperative for
mining and metals companies to remain nimble and sure-footed in how they manage these
fast-changing risks in order to balance the relative risk/reward equations demanded by both
the Board and shareholders.

The business risk report Mining and metals 20122013

The top 10 business risks for


mining and metals
Resource nationalism

The uncertainty and destruction of value caused by sudden


changes in policy by the governments of resource-rich nations
cannot be understated as projects around the world have been
deferred and delayed, and in some cases investment withdrawn

altogether because of the changed risk/reward equation.


Miners should continue to engage with governments to foster a
greater understanding of the value a project brings to the host
government and be better able to negotiate appropriate trade-offs
that preserve the value to both mining and metal companies and
governments. This includes encouraging governments to take a
broader view of the return from natural resource development, as
well as negotiating tax incentives and offsets.

01

Resource nationalism retains the number one risk ranking with


many governments around the world going beyond taxation in
seeking a greater take from the sector, with a wave of
requirements introduced around mandated beneciation, export
levies and limits on foreign ownership.

Skills shortage

Signicant risks associated with skills shortage include impact to


production, project delays, and increasing labor costs. Identifying,

attracting and retaining critical operational and construction skills


remains a top priority for the mining and metal sector. Innovative
approaches used by organizations include:
1. Differentiated employee value proposition to retain
employees, companies are offering not only attractive
compensation but also individually tailoring non-nancial
benets

02

The acute skills shortage seen in Australia and Canada has spread
to more places during the past year, with projects in Indonesia,
Mongolia, Brazil, Chile, Peru and Mozambique all plagued by this
challenge. Strong commodity prices and condence in the
long-term sector fundamentals have reinvigorated investment in
mining and metals to quickly develop new projects or ramp up
production from existing ones. This increased investment is in turn
driving demand for skilled workers around the world and drawing
on the same global pool of talent. The risk is that this could slow
growth and increase costs.

2. Accessing non-traditional and underrepresented labor


pools such as women and indigenous communities
3. Resourcing from other sectors companies are hiring
resources from industries with similar and/or complementary
skills, such as oil and gas, and manufacturing

Infrastructure access

The key inuences on infrastructure nancing include:


The changing role of government to planning, approving and
incentivizing nancing of infrastructure
The rising number of foreign investors in infrastructure from
countries like China, Japan, Korea and India

Funding from institutional investors including pension,


sovereign wealth and infrastructure funds
The increasing focus on corporate governance which has seen
closer Board scrutiny of the return on investment which often
results in projects with large infrastructure needs being less
likely to be approved

03

The long running minerals super-cycle has made lower quality or


remote deposits viable, with the lack of sufcient infrastructure
being the primary obstacle to the development of these resources.
Governments are no longer the natural vehicle through which
infrastructure projects are funded, mainly due to their current
weak budgetary positions. This means that nancing has fallen to
the private sector. Large miners with balance sheet strength are
under increased shareholder pressure to restrict new capital
expenditure, and small miners often lack required nancial
strength to solely develop these projects.

To full infrastructure needs, changes need to be made to


procurement processes and risk allocation between government,
users, developers and funders. For this to be effective, traditional
views around construction risk, residual value, revenue/pricing
risk, capacity, operational control, credit risk and tax need to be
re-assessed. Unless the commercial risks can be adequately
addressed and the take or pay contracts be bankable, then
development of infrastructure will continue be slower and more
complicated than would appear necessary.

The business risk report Mining and metals 20122013

Cost ination

04

Cost ination in the sector is expected to intensify over the next


several years, due to a number of factors, including labor, energy,
ore grades, currencies, supplier constraints and taxes. In the
prevailing environment of global economic uncertainty, softening
commodity prices, higher input costs, and strengthening local
currencies in many mining and metals jurisdictions are increasing
the pressure on margins.
Companies are revisiting their capital expenditure plans as

spiraling capital costs threaten the viability of new projects.


Furthermore, high crude oil prices, wage ination and increasing
complexity are driving operating costs. In response, mining and
metals companies are reviewing their portfolios to identify
underperforming assets, with plans to shut down or divest high
cost and non-core assets. Industry consolidation, automation
technology, owner-operated mines and investment in energy
assets are some of the steps that companies are taking to lessen
the impact of rising costs.

Capital project execution

05

There is a massive pipeline of projects in 20122015. At the same


time, there has been high delivery cost ination and heightened
macroeconomic uncertainty. This uncertainty has been putting
downward pressure on prices of mined commodities since 2H
2011, with mining and metals companies now reconsidering,
revising and prioritizing or sequencing previously announced
capital project plans to mitigate these factors.
Mining and metals companies are adapting to emerging capital
project risks by:
Raising the bar on business case justication and rigor
there is a renewed focus on the integrity of data around

estimated project costs and benets to aid/improve


managements level of decision-making condence
Prioritizing the investment pipeline to align with a changing
appetite for cost and cash exposure as leadership teams
develop customized criteria to sequence their project pipeline,
prioritization considerations extend beyond return on
investment to strategic alignment, cash ow exposure and
delivery complexity
Enhancing project controls to drive standardized delivery
against plan project teams must embed the right project
control disciplines to drive delivery against plan in a
standardized and consistent manner

Maintaining a social license to operate

06

The consistent ranking of maintaining a social license to operate


within the top six risks over the last ve years demonstrates it is
an important element of doing business as opposed to being a
compliance exercise. While the reputation of being a company
which does the right thing can provide a competitive edge through
better access to capital and solid government relationships, it is
essential in being able to access the next project. Trends which
challenge companies include:
Increased expectations stakeholders such as governments
and communities want more from mining and metals
companies operating in their jurisdictions, from basic nancial
returns to benets for the community and the country. To stay

ahead, companies need to be proactive, timely and transparent


in their dealings with these stakeholders
Acquisition challenges Acquisitive companies need to be
increasingly aware of the standards of their potential targets,
moving quickly to set clear expectations of how they do
business and build rm partnerships with stakeholders
Changing how business is done companies are changing how
they approach business by focusing more closely on building
strong partnerships with stakeholders and communities right
from the start so they are engaged and understand every
aspect of the project

Price and currency volatility

07

Equity markets are becoming increasingly sensitive to


macroeconomic news, and for many organizations increases in
commodity prices are often not fully impacting share prices,
whereas decreases are. The erosion of the gold premium is a
prime example. This is creating differing asset valuation
expectations, impacting the ability to complete transactions.
Companies operating costs are often not in their functional
currency, and therefore volatility in foreign exchange prices can
put extreme pressure on them. To combat this volatility, mining
and metals companies need to consider metals price and currency
hedging strategies, and hedging inputs to production. Scenario
planning could help them assess their ability to withstand price
shocks and capitalize on the current metal price cycle.

During periods of great volatility, mining and metals companies


most value exibility to vary the level of production at little or no
cost. Dynamic Discounted Cash Flow (DCF) and Real Option (RO)
modelling are providing decision-makers with enhanced cash ow
models that improve risk assessment and nancing options of
mining projects. Only a handful of mining and metals companies
are, however, implementing these techniques and generally seem
to be battling with scenario planning. We expect to see increasing
board level focus on currency and metal price volatility strategy
and management as they strive to recognize and exploit value
from volatility.

The business risk report Mining and metals 20122013

Capital management and access


The risk of sub-optimal allocation of capital can have a signicant
and long-lasting impact. Companies are responding to this risk by
building options and exibility into their capital agendas through:
Opportunistic renancing

08

Boards in 2012 are facing an extremely complex and uncertain


environment within which to undertake capital allocation
decisions. The volatility seen on capital markets is raising the risk
that funding to the sector could become increasingly limited.
Rising cost ination and a volatile investment backdrop are
challenging the returns expected on major organic growth
programs. And an apparent undervaluation by the markets,
amidst increasing pressure for greater return of capital to
shareholders, is driving companies to revisit their overarching
capital allocation strategies.

Strategic divestments and reallocation of capital


Innovative approaches to capex discipline
The challenge for mining and metals companies is to remain true
to their long-term strategy, while building in exibility to respond
to short/medium term opportunities and risks.

Sharing the benets

Governments are placing pressure on mining and metals


companies to take a greater role in supporting the broader
community through social and logistical infrastructure,
community developments, and local hiring and procurement
practices
Local communities are not just looking for minimal disruption
but also to share the economic and social benet from local

mine operations. They have a lot of power to disrupt projects if


their needs and interests are not met
Employees are seeking higher wages and greater workplace
benets and can incite industrial unrest if they are not achieved

09

As the mining sector continues to ourish while other sectors


ounder, a wider range of stakeholders are looking for a greater
share in the perceived prots. These stakeholders feel entitled to a
portion of the value created by mining and metals companies and
balancing these varied and competing expectations is challenging.

Suppliers can charge greater premiums as mining and metals


companies are dependent on their goods and services to
increase production output
Shareholders are expecting a greater return on their
investments for the perceived risk of owning mining and metals
stock, squeezing the prots already shared amongst the other
stakeholders

Fraud and corruption

In response to new regulation and enforcement, companies are


actively changing the way they do business:

Compliance monitoring this is becoming crucial in itself and


additionally many companies are seeking assurance of their
compliance
Third party liability mining and metals companies are
substantially increasing due diligence initiatives around third
parties as part of their corruption gap analysis, which includes
specic anti-corruption provisions in their standard contract
terms

10

Fraud and corruption remains on this years risk radar due to the
increased political risk weve observed in a number of key mining
and metals companies investment destinations, and also
increased regulation and enforcement activities. The effects of
fraud and corruption can impact a companys reputation, social
license to operate and bottom line. Additionally, the extent of
fraud and corruption and the associated effect on both private and
public citizens of countries have led governments to implement far
reaching regulatory changes.

Whistle-blowing companies have been forced to become


active in encouraging internal whistle-blowing by providing a
credible alternative to external whistle-blowing

The business risk report Mining and metals 20122013

The top 10
business
risks

10

The business risk report Mining and metals 20122013

(same as 2011)

01

Resource nationalism
Resource nationalism continues to be the number one risk facing
mining and metals companies as governments go beyond taxation
in seeking a greater take from the sector. The uncertainty and
destruction of value caused by sudden changes in policy by the
governments of resource-rich nations cannot be understated.
We are observing three key trends of resource nationalism which
we will believe will continue throughout 2012/13:

1. Imposition/increasing of royalties or mining taxes


Amendments to mining and tax laws can result in changes to capital
allocation based on a weaker risk/reward prole.
The announcement in 2010 of a proposed new super prots
mining tax in Australia had a signicant ripple effect around the
world. Many mining and metals jurisdictions announced increases in
taxes and royalties during the course of 201112 and many looked
at Australias action as commercial cover for proposed changes. For
example, in March 2012, an Indian Government taskforce started
working on modalities for a new levy on minerals mined on forested
regions of the country. The proposal for a new levy followed
demands raised by several provinces in India for a new mineral
resource rent tax with a minimum of 50% on super prots earned
by miners. The provincial governments had suggested modelling
the new resource rent tax along the lines of the Australian
proposal.1
Other tax and royalty increases are being proposed and enacted
across the world in the resource rich emerging markets. After the
2011 elections, Peru enacted a new mining tax and royalty regime
that used as a template similar changes that occurred in Chile the
year before. These levies are based on net mining income with
certain adjustments, e.g., interest expense is not allowed as a
deduction.

2. Mandated beneciation/export levies


Many governments are now seeking to have minerals beneciated
in-country prior to export. South Africa has announced a
beneciation strategy, as has Zimbabwe, Indonesia, Brazil and
Vietnam. In theory, this will capture more of the value-chain as the
products will achieve higher prices.
Changes to the risk prole due to mandated beneciation include:
The high cost of establishing reneries or smelters if not already
established in the country
The need for both low cost power and infrastructure for
beneciation plants both of which are often in short supply in
these countries
The need for skilled labor for value-added processing
Loss of exibility in global supply chain
Concentration of investment risk
Relatively higher taxes on value add
Less integration with customers supply chain
Threats to existing business models where miners are forced to
move downstream
Typical of the reaction to mandated beneciation came from one
company which made the following comment on the changes to the
Indonesian export regime while they were happy to commit
US$500m to Indonesia for a mine, they were not happy to commit
US$1.5b for a mine and a smelter as the returns did not justify that
much exposure to the country.2

During 2011 and for the rst six months of 2012, a number of
countries have announced or enacted increases to taxes or royalties
including Democratic Republic of Congo, Ghana, Mongolia, Peru,
Poland, and the USA, to name a few.

In order to better ensure in-country beneciation, governments are


imposing new steep export levies on unrened ores. For instance
Indonesia, as part of its mining tax changes, has proposed a new
export levy of 25% on mining exports in 2012, increasing to 50% in
2013. The Indonesian Government said in announcing the proposal
that it is seeking to develop its mining sector, create jobs and turn
itself into a producer of higher value nished goods from an
exporter of raw materials.

1 India working on mining tax, Mining Weekly, 20 March 2012

2 Anonymous company quote to Ernst & Young contact

The business risk report Mining and metals 20122013

11

3. Retaining state or national ownership of resources


Governments are also seeking to ensure that they retain ownership
of their minerals, which is not a new phenomenon. While trying to
eliminate discussion about nationalization, South Africa, which
already has Black Economic Empowerment (26% participation), is
also canvassing the idea of the mandatory participation of a state
owned mining company. Indonesia has announced a plan to limit
foreign ownership of mines to 49% after 10 years. Zimbabwe has
already commenced its 51% indigenization laws, and Mongolia has
placed a 49% cap on foreign ownership of strategic mines. China
and India have restrictions on foreign ownership of certain minerals.
These changes in ownership laws can have a signicant impact on
the reward miners expect to receive for the risk they have taken.
When partial divestment is done part way through a mine life, the
mining company has paid for 100% of the investment, including the
upfront exploration, development, commissioning and early
operating risk, but will be giving up a percentage of the future
investment return. That can be the equivalent of a very high tax.
Even if they can sell shares to locals, the value of those shares will
likely be at a reduced market value as fewer buyers can afford an
interest so they may have to sell down ownership at a loss. There is
an increased need for project economics and modelling before any
investment is undertaken to factor in the probability of changes in
policy, e.g., how will forecast returns be affected if there is a 40%
chance the mining and metals company has to sell 49% of its
shareholding at a loss?

Capital, risk/reward ratio and the sell decision


The increasing spread of resource nationalism has an effect on
where mining and metals companies invest their capital. Mining and
metals companies are weighing up the risk-reward ratio and will
take into account any potential policy changes when modelling the
economics of any future projects. In the 2012 Capital Condence
Barometer survey undertaken by Ernst & Young, almost two-thirds
of surveyed senior mining and metals industry executives indicated
that they will invest in organic growth over the next twelve months.
This means they will be looking to invest capital in new, greeneld
sites or in expanding existing operations. In either case, they will

12

have a choice on the location of that investment and recent or


proposed changes in tax regimes will impact those choices. The
hurdle rates for those investments will have to take into account the
higher risk associated with resource nationalism.
Mining and metals companies will also be considering the impact of
resource nationalism on their existing projects. Changes to the
mining laws or tax regimes will lead to a re-evaluation of a mining
and metals companys operations. New taxes or the prospect of new
levies will weigh into whether the company divests its interest or
sells down to maximize its investment return.
Mining and metals companies should evaluate current operations
just as they evaluate new investments and the risk reward ratios
have changed in those jurisdictions where resource nationalism is
occurring or trending. Companies will be working this into their life
of mine models.
The average global risk has increased for investment so the related
reward must be higher in order to make the requisite investment.
Mining and metals companies will make choices for future and
current investments across projects and countries based on the
expected returns as risk adjusted. Those governments which
increase their take will lower the returns and increase the risk for
mining and metals companies, and will jeopardize future foreign
direct investment.

Broader economic impact of mining investment


Governments are currently seeking a higher return on their natural
endowment but should consider a broader view of the return from
natural resource development. Governments will not only realize
royalties and direct mining taxes from the natural resource as it is
developed, but will also realize income taxes and other taxes such
as VAT on purchases of equipment and other property, ad valorem
taxes and payroll taxes. In addition, mining activities provide direct
mining jobs and indirect jobs through infrastructure development
and suppliers, and the associated income and payroll tax revenue
from those jobs. Hence, there is often a signicant multiplier effect
associated with the development of new mines.

The business risk report Mining and metals 20122013

Andy Miller
Global Mining & Metals Tax Leader, Ernst & Young
With the massive increase in resource nationalism, comes an increased need for tax directors to be
more involved in strategic risk decisions.

Product of consultation
In many resource-rich countries, the capital investment can be
signicant. For example, in Peru, the Government is forecasting
investment into its mining sector of US$53b over the next ve
years.3 As previously mentioned, a recent change of regime in Peru
led to an increase in tax on mining operations. In anticipation of the
regime change, organizations in Peru met with the new
Government, presented comparisons of the government take in
alternative mining and metals locations, and discussed a range of
options to enhance tax revenues from the current and future
operations in Peru. The new levies were based on net income from
the sector and there was recognition that new revenues were
needed. In addition, many of the big mining and metals companies
in Peru have agreed to pay additional taxes over that agreed in
their stability tax agreements, as long as they are not
unreasonably high.4
The inevitability of increased government take during a super-cycle
has led mining and metals companies to move from outright
opposition to changes in scal terms, to negotiating offsets. This
has been because the political weight behind an increased take has
been increasing but value restoring trade-offs are politically
achievable. Some of these offsets include:

Mining and metals companies are looking at the government


consultation process as a means of preserving value as opposed to
just defending scal terms.

Corporate governance
Resource nationalism and political changes in resource-rich
countries creates further unpredictability for organizations
investing in long-term projects. There will be increased political
uncertainty in determining project economics, which increases the
overall cost of doing business and the related risk. In addition,
political changes have an effect on contract stability and often this
is not just a one-off event. Countries can make a series of changes
to their mining laws over a number of years.
As a result, the decisions about investments have become riskier,
which will require greater involvement by the board in tax matters
and tax planning. In 2009, the Ernst & Young Mining and Metals Tax
Survey found that only 65% of tax directors presented periodically
at the board level. We predict that with the increase in resource
nationalism, tax directors will be getting more airtime with the
boards of their companies, which will need to increase their focus
on tax considerations and implications on risk.

A more efcient (prot based) taxation system


Removal of inefcient taxes
Speeding up the development approval process
Improving exibility of labor

Steps mining and metals companies can take to respond to this risk:
Invest in transparent relationships with host governments to
foster a greater understanding of the value of the project to
the host

Align with multi-lateral agencies, such as the World Bank, to


achieve a prominent victim status in the face of mounting
resource nationalism

Align with the host governments long-term economic and


political incentives and thereby become an invaluable part of
the infrastructure in the host country

Partner with state owned enterprises that have strong


Government-to-Government relationships
Encourage direct government participation

Focus on generating direct and sustainable benets for the host


community through pro-active and well organized social and
community development programs

3 Peru dangles its investment credentials, MiningnewsPremium, 23 May 2012


4 Peruvian miners brace for tax news, Financial Times, 25 August 2011

The business risk report Mining and metals 20122013

13

(same as 2011)

02

Skills shortage
Identifying, attracting and retaining critical operational and
construction skills remains a top priority for the mining and
metals sector in 2012. Continued sector growth with 136 new
projects planned or announced in the 2012 calendar year1 once
again magnies and escalates the problem. However, the outlook
on investment is cautious, with companies prioritizing and
sequencing investment in projects, thus impacting skills demandand-supply dynamics. The scaling back or shelving of several
large projects during the year may provide some temporary relief
from the skills shortage. However, in this volatile environment,
it is increasingly difcult to forecast and plan future workforce
requirements, and this is why skills shortage remains the second
most critical risk in the mining and metals sector.
The risks associated with skills shortages are signicant:
1. Impact to production output there is a risk that insufcient
skills may limit current and/or planned output. According to BHP
Billiton, Australias resources industry needs an extra 170,000
workers in the next ve years.2 In Canada, the Mining Industry
Human Resources Councils 2010 National Employer Survey
reported that 40% of the Canadian mining workforce will be
eligible for retirement by 2014, taking with them an average of
21 years of mining sector experience each, and driving the need
for skilled workers to 60,00090,000 by 2017.3
2. Delay, downsizing or cancellation of projects the shortages in
both skilled and unskilled labor contribute to project delays, the
impact of which is felt by both mining and metals companies and
contractors. Meeting contractual obligations will be difcult, and
the viability of projects will also be impacted as there is not
enough labor to successfully implement the number of planned
projects. In Canada alone, operations in 32 Canadian mines were
either suspended or shelved during 20092011.4 Even the
larger mining and metals companies are experiencing the impact
of the skills shortage, e.g., rising skills costs was one of the
contributing factors that led to Newmont Mining writing off the
Hope Bay gold project.5

1 Raw Material Group


2 Australian mining giant BHP Billiton estimates that the industry will need a further..., Federal
Government Broadcast Alerts, 3 October 2011, via Factiva 2011 Media Monitors Australia Pty Ltd.
3 http://magazine.mining.com/issues/1005/PDFWeb.pdf
4 Canadian Mining Industry Employment and Hiring Forecasts, 2011
5 Newmont puts Hope Bay gold project on hold, http://www.cbc.ca/news/canada/north/
story/2012/02/01/north-newmont-hope-bay.html, accessed 17 May 2012; Newmont Mining posts
4Q loss on project writedown, http://nance.yahoo.com/news/Newmont-Mining-posts-4Q-lossapf-4285689275.html, accessed 17 May 2012

14

3. Global mobility the current labor shortage within the mining


and metals sector necessitates a global approach to mitigate the
risk as there are often insufcient numbers and/or skills available
in the local market. Therefore, being able to attract and mobilize
key talent globally in a cost effective and efcient way, whilst
ensuring compliance with local immigration and tax regulations,
becomes a critical requirement. This, however, does not always
receive local community and government support, and in some
cases government policies and requirements may in fact restrict
the ability to access and move talent globally.
4. Increasing labor costs competition for scarce labor increases
employment costs and erodes production margins. In addition to
varying commodity prices, companies now have to contend with
an increasing cost base. According to Jac Nasser, Chairman of
BHP Billiton, the cost of doing business in Australia is increasing
due largely to higher wages in the country. The resource projects
in Australia cost around 40% more than the cost of a similar
project in the US Gulf Coast.6
Companies that are able to plan ahead are using a number of
strategies to deal with skills shortages; both short and long term.
Some of the more innovative approaches we are observing are
as follows:
1. Differentiated employee value propositions
In this competitive labor market, talented employees have
choices, and therefore companies must differentiate themselves
from their competitors by developing compelling offers to attract
and retain the best talent. Ernst & Youngs work developing
employee value propositions for mining and metals companies
clearly shows that remuneration and career opportunity are
rated as equally important by employees and that there are a
range of other factors that inuence their employment decision.

6 Nassers defence is all-out attack, The Age, 17 May 2012, via Factiva 2012 Copyright John
Fairfax Holdings Limited

The business risk report Mining and metals 20122013

Louise Rolland
Executive Director, Advisory, Ernst & Young
There is no easy x to the skills shortage issue, but being creative and exible in your approach can
open up new pools of talent.

Companies need to understand what is important to their


targeted workforce and be creative in providing not only an
attractive compensation but also a range of additional employee
benets. In order to retain employees, companies need to
engage with them at multiple levels7 and clearly communicate
the full range of benets of employment with their company.
a. Attractive compensation
Companies are becoming increasingly focused on employee
related costs. Remuneration arrangements are being
reviewed and rebalanced to ensure they are fair and
competitive for the individual, while being affordable and
sustainable for the organization. In addition to taking a more
targeted approach to compensation design and provision,
companies are focusing on enhancing their employees
understanding of the remuneration arrangements on offer,
and the purpose for which each remuneration element is
being provided.
b. Non-nancial benets
Companies are also employing a range of non-nancial
benets and arrangements to assist with workforce
recruitment, engagement and retention. One of these is
exible work schedules to enable employees to have a
positive work-life balance while ensuring operational
requirements are achieved. This is especially prevalent in the
development of FIFO/DIDO rosters. To provide greater
balance of time in home location with time on site, rosters

have evolved over recent years from 2 weeks on 1 week off to


9 days on 5 days off, to 8 days on 6 days off, and now to a
8/6/7/7 rotating roster. 8 In addition, companies are also
providing additional exibility such as career breaks, working
from home, the ability to work part-time and parenting leave
options as a means of attracting and retaining talented
employees. Other benets that are typically being offered
include relocation assistance, in-house and online education
alternatives for career development, and free or subsidized
childcare facilities.
c. Individually tailored employee experiences
In addition, mining and metals companies are tailoring their
attraction and retention strategy so that they are aligned to
employees geographic location, nationality and life stage who
may have different needs and expectations. Greater
sophistication in proling the market will better enable
Human Resource Directors to respond to the threat that labor
shortages pose to their companys competiveness. Leading
organizations are utilizing predictive modeling techniques to
tailor their offerings to target different labor segments and
better match job roles with candidate preferences. A key
trend emerging is the increased importance both candidates
and employees place on career development and progression
as a driver of attraction and retention. Nowhere is this more
pertinent than in the mining and metals sector where a lack of
clear career pathway and opportunities are often cited as a
reason for leaving.9

b. Non-financial benefi ts
(includes flexibility,
career development)

a. Attractive compensation
(includes remuneration,
incentives, benefits, allowances)

Set remuneration at competitive


but not inflationary levels

Understand what is important

7 Attracting workers to the mines and retaining them, Ernst & Young, 2008

c. Individually tailored

Understand what is different


across workforce segments

8 8/6;7/7: Example of rotating roster where working 8 days on/6 days off and 7 nights
on/7 nights off
9 Career and life survey, Ernst & Young

The business risk report Mining and metals 20122013

15

Five things that leading companies do well when attracting and retaining staff
1. Get the employment offer right and effectively communicate
and reinforce it

4. Understand employee needs and the markets in which they


reside for effective workforce planning

2. Develop effective career pathways and well-aligned employee


development programs

5. Execute well across attraction and recruitment, and


development and progression

3. Build internal capability to effectively manage people

2. Accessing non-traditional and under-represented labor pools


Women and indigenous workers are two signicant talent pools
that are not yet fully leveraged by the sector. Further, there are
skills and experience in other sectors which could be effectively
leveraged into mining and metals organizations. With policies
and practices catered to address the needs and requirements of
these specic groups, the sector could potentially increase the
available talent pool.
Indigenous engagement is crucial since indigenous communities
represent a large source of labor close to mining and metals
operations, and are often one of the fastest-growing
employment pools in the country. To utilize this resource pool,
many companies have set a minimum target to employ
indigenous workforce at mine sites, and governments are
implementing incentive programs for these communities to gain
the appropriate skills to enter mining-related employment, e.g.,
the Canadian Indigenous Skills and Employment Partnership.10
This benets not only the indigenous communities, but also
contributes to the companies social license to operate.
The effective participation of women in the sector is currently
low in Australia, women represent only 18% of the workforce in
mining, as opposed to 45% of the total workforce,11 and in
Canada, 14% of the mining labor force, as opposed to the
countrys average participation rate of 47%.12 The participation
of women in the sector is often limited due to issues such as the
lack of part-time work in the sector, a culture of long hours,

remote locations of mines, family responsibilities and the


extended problems of working in a male-dominated environment.
In many countries, formal programs are now in place to increase
the national participation of women. For example, the Federal
Government of Australias policy to increase female participation
in mining includes tax deductibility of work-related child care
expenses, fringe benets tax removed from employer sponsored
childcare, and education programs aimed at employers to inform
on gender equity, amongst others.13
3. Sourcing workers from other sectors
The shortage of mining and metals skills has prompted some
companies to consider resources in other sectors with similar
and/or complementary skills, such as oil and gas, engineering,
construction and manufacturing. Targeting resources in these
sectors has created a widening resource pool of both technical
(e.g., electrical trades, tters and turners) and professional (e.g.,
civil and mechanical engineers) skills. Further, the relative growth
of mining and metals versus other sectors may also provide more
immediate access to resources due to slowing down and
contraction within these other sectors. For example, in August
2011, BHP Billiton established an online portal to take
applications from the 800 workers affected by a companys
decision to cut jobs in Illawarra, Australia. In the wake of the
US$9.5b capital expenditure plan, BHP Biliiton is hiring from
allied sectors for its operations in Illawarra, Queensland and
Western Australia.14

Steps mining
companies
and can
metals
takecompanies
to respondcan
to this
takerisk:
to respond to this risk:
Source skills from aligned sectors and a broader demographic
Account for demographic and diversity factors when making
investment decisions
Initiate programs that encourage semi-skilled and retired
workers to re-enter the work-force
Target initiatives to retain critical skills held by older workers
close to retirement

Implement early labor scheduling and sourcing within mine


planning
Develop sustainable skills development programs to ll
these gaps
Develop strategic alliances with institutions and communities
Target initiatives to optimize productivity
Substitute capital for labor through innovation

Create employment packages focused on career development


opportunities

10 Attracting workers to the mines and retaining them, Ernst & Young, 2008
11 Attracting workers to the mines and retaining them, Ernst & Young, 2008
12 Canadian Mining Industry Employment and Hiring Forecasts 2010, Mining Industry Human
Resource Council

16

13 Gender pay equity and associated issues for women in mining Survey Report, The AusIMM,
http://www.ausimm.com.au/content/docs/gender_pay_equity_wim_report.pdf,
accessed 24 May 2012
14 Sacked steel workers wanted in WA, Australian Broadcasting Corporation (ABC) News, 24 August
2011, via Factiva 2011 Dow Jones & Company, Inc.

The business risk report Mining and metals 20122013

(same as 2011)

03

Infrastructure access
While prices have moderated over the past year, they remain
above historical averages driven by economic growth in the
rapidly developing economies. This continues to challenge the
mining and metals sector with its supply response. The need
to expand existing production or develop stranded deposits
is keeping infrastructure access in the top three sector risks.
Indeed, global mining capital expenditure is expected to grow 14%
in calendar year 2012. This is being driven by a range of mining
development projects in developed economies like Australia
and emerging markets of China, and Africa.1 Resources sector
investors from countries like China, Japan, Korea and India have
emerged as new infrastructure sector investors in the last few
years, in addition to traditional funding from OECD countries.
For example, Japanese rm Mitsubishi Corp is championing the
Oakajee Port and Rail development in Australia2 and Chalco
and Rio Tinto are developing the Simandou iron ore project in
Guinea, Africa.3
One of the clear impacts of the long running minerals boom has
been that resource deposits long classed as marginal or
uneconomical have gradually become more viable. Typically these
deposits have been of lower quality or remote from existing supply
chains and thus the lack of sufcient infrastructure, either logistics
or secondary processing, has been the primary obstacle to rapid
development of these resources. Speed is seen as essential in
developing these deposits as there are only so many of these
standard assets that will be developed. Remoteness naturally brings
additional challenges in terms of cost, risk and scale of development
of the required transport, utilities and supporting infrastructure. We
see a real divide in the approaches of individual organizations:
The tier one mining and metals organizations have the balance
sheet strength to proceed with integrated mine/logistics
developments but are under shareholder pressure to restrict new
capital expenditure

The old paradigm was that governments tended to fund larger


logistics networks and then develop regulated tariff structures on
an open access basis. However, the current poorer condition of
government nances globally means that direct investment in
mining and metals related infrastructure is of lower priority than it
has been in the past. Those organizations without the balance sheet
strength or available nancial resources are therefore faced with
two options:
Collaborate with similar sized competitors or larger off-take
customers to jointly develop the required infrastructure. For
example, Sundance Resources, which is developing the Mbalam
iron ore project in West Africa, is collaborating with regional iron
ore developers Core Mining and Equatorial Resources to develop
the infrastructure, and is also the subject of a takeover offer by
Hanlong Mining, a Chinese company4
Where competition regimes exist, seek access to the existing
privately developed networks (the Pilbara iron ore rail network
access dispute between iron ore miners in Western Australia is an
example of this process)5
A key issue in structuring transactions for pivotal supply chain
infrastructure is control: control over the operational protocols and
expansion prole gives an organization a signicant advantage over
its competitors in setting the speed with which product is delivered
to the market. Negotiations over joint development agreements
and third party access terms are typically long and complex as the
control issue is dealt with. Anketell Port in Western Australia and
the Wiggins Island Rail expansion in Queenland, Australia are both
examples where negotiations on control have been extensive and
have delayed the nalization of project delivery. Our view is that a
signicant portion of the synergistic value that would be generated
in a more cooperative approach is being lost.

The smaller mining and metals oganizations struggle to fund


large sole use infrastructure developments

1 The global mining machinery handbook, 14 March 2012, Morgan Stanley


2 http://www.opandr.com/, accessed on 20 June 2012
3 Chinalco sets up consortium to develop Simandou iron ore project,
Xinhuanet.com, 29 November 2011

4 Sundance Resources regulatory lings to Australian Stock Exchange in 2011 and 2012
5 Rio Tinto completes formation of Simandou joint venture with Chalco, Rio Tinto press
release, 25 April 2012

The business risk report Mining and metals 20122013

17

We expect the key inuences on the nancing of infrastructure


to be:

1. The changing role of government


The role government plays in infrastructure development continues
to evolve. We are seeing three trends emerge:
Reduction of direct government funding allocated to the
development of supporting infrastructure driven by global
pressure on government budgetary positions
Increased pro-activity from governments in the planning and
approval processes to both enhance the efcient development of
the necessary infrastructure (avoiding wasteful duplication of
supply chains), and to preserve effective competition for valuable
rail and port rights. In the developing nations, the focus is
typically on the rst of these issues
Provision of incentives for the private sector to nance and
provide necessary infrastructure either through tax incentives,
orderly risk transfer, or project approvals

2. Increasing inuence of foreign customers


We are observing a continued inuence of Chinese, Indian and
Korean investors in infrastructure development. These companies
tend to have government backing (in terms of funding and strategy)
and tend to deal directly with local governments. They look to
partner with junior mining and metals companies and local
government in developing projects and it is common for them seek
pit to port control and off-take commitments in return for otherwise
unavailable debt and equity funding. Junior mining and metals
organizations, while apprehensive over surrendering logistics
control, typically have few other viable funding options and thus
there is substantial nancial pressure to agree to accept those
terms and conditions.

3. New sources of infrastructure funding from institutional


investors
Pension, sovereign wealth and infrastructure funds have emerged
as a new source of funding, with a preference to fund projects
where there is limited un-pooled commodity risk. Pension investors
are extremely reluctant to take raw usage risk. These investors will
typically require material greeneld or browneld expansions to be
supported by take or pay contracts from a bankable mix of mining
and metals organizations to be attractive. We note that third party
nancial investors do not benet directly from the synergies that
accrue to producers for control of the supply chain and thus may
require a yield premium. This further reduces the viability of

projects, and biases against resource developments without solid


logistics infrastructure or sponsored by tier one organizations.
Mining and metals companies are increasingly looking at
partnerships to provide additional funding sources. Whilst these
models can introduce a broad range of additional risks, increase the
complexity of the process and include additional development
challenges, in some cases they can provide a viable alternative.

4. Financing market challenges and ongoing volatility


The global nancial crisis of 2008 resulted in increased debt
pricing, tightening of lending covenants, reduced lending tenors
and a signicant contraction amount of bank debt available to
nance infrastructure projects. There has been a consequent
adjustment in the banks participating in the infrastructure project
nancing market. The impact of the departure of a number of well
known European banks from this market has been partially offset
by increased participation from Asian and Canadian based lenders.
However, for a robust project with an appropriate commercial
structure, debt funding remains a viable funding option as shown
in the Wiggins Island Port project in Queensland, Australia. The
current volatility in nancial markets and also the upcoming
introduction of Basel III means the current challenges for nonrecourse project nance structures to secure funding are likely
to continue.

5. Increased focus on corporate governance


Boards are placing greater scrutiny on where their investment
dollars are spent. This is being driven to some degree by the poor
condition of the global funding markets and the consequent
limitations on the terms, availability and pricing of capital. This has
triggered further internal competition for investment capital
between business units. Boards are thus focusing on projects with
lower risk and capital usage proles. Projects with substantial
infrastructure development tasks have higher capital requirements
and tend to face lower overall returns. This means, in some
instances, projects are being delayed in order to ensure more
robust analysis, justication and scope rationalization prior to
receiving approval. In addition, we are seeing signicant changes in
the relative cost of developing projects reduced productivity,
changing sovereign risk proles and the level of competition for
skilled labor and materials are all impacting on the viability and
priority of projects across the globe. The Minerals Council of
Australia recently cited that low productivity growth and rising
cost structures in Australia have contributed to deteriorating
international competitiveness over recent years.6

6 Boom under threat from higher costs, Australian Financial Review, 30 May 2012

18

The business risk report Mining and metals 20122013

Neal Johnston
Partner, Infrastructure Advisory, Ernst & Young Oceania
Changing market conditions will force resource producers to amend infrastructure development plans.
Given the softening commodity prices, the cost curve will play a more critical role in determining which
projects will proceed and most importantly when they will be developed.

Outlook
Infrastructure blockages remain prevalent in rail and port
infrastructure supply chains and are increasingly impacting mine
supporting infrastructure and power and utilities networks due to
the remote development locations.
The current uncertainty over global nancial markets has added
additional risk to the process of pit to port mine development. A
downward trend in resource prices would force an immediate
reassessment of marginally economic deposits, so the need for
rapid development while the price environment remains benign is a
key concern for all mining and metals organizations. The task then
is unlocking the value of co-ordination and collaboration between
organizations so that the full infrastructure cost prole is efciently
allocated and funded.

With governments less able to fund supply chain infrastructure as it


has in the past, a new paradigm has formed whereby the private
sector needs to play this role. This necessitates changes to the
procurement processes and risk allocation between government,
users, developers and funders. For this to be effective, traditional
views around construction risk, residual value, revenue/pricing risk,
capacity, operational control, credit risk and tax need to be
re-assessed. Unless the commercial risks can be adequately
addressed and the take or pay contracts bankable, then
development of infrastructure will continue to be slower and more
complicated than would appear necessary.

Steps mining and metals companies can take to respond to this risk:
Consider the extent to which infrastructure decits may impact
on enterprise value
Understand the return on all capital expenditure, including
infrastructure, and consider appropriate nancing
Look for other stakeholders to co-develop a solution with shared
benets

Investigate partnerships with other potential stakeholders in


expanded infrastructure to innovate nancial arrangements
including off-take
Improve mine planning to assist in assurance over optimal levels
of take-or-pay commitments

The business risk report Mining and metals 20122013

19

(Up from 8 in 2011)

04

Cost ination*
Over the past decade as the sector and its suppliers have
struggled to increase supply, cost ination has re-emerged
as a major risk for mining and metals companies globally. It is
estimated that the sector experienced cost ination of between
10% and 15% in 2011, with overall cost ination averaging
roughly 57% in the last 10 years (this equates to a doubling
of costs every 1014 years).1 Cost ination in the industry is
expected to intensify over the next several years due to a number
of factors, including labor, energy, ore grades, and taxes.

Companies revisit robust capital expenditure plans

Subdued demand and low commodity prices, while costs


continue to rise

In early May 2012, AngloGold Ashanti approved capital investment


for the Kibali gold mine in the Democratic Republic of Congo (DRC),
which it is developing with project partner Randgold Resources.
Total capital expenditure for the project (including contingencies)
has increased to US$2.2b versus the 2010 feasibility study
estimate of US$1.4b. Though Kibalis mine design and mine
schedule has been optimized since the original 2010 feasibility
study, this 55% increase in capital expenditure highlights rampant
capital cost ination across the mining and metals sector.7

According to Rio Tinto CEO Tom Albanese, softening commodity


prices, higher input costs, and soaring Australian and Canadian
dollars are pressuring margins.2 Corroborating this view, several
mining and metals organizations have cited the twin evils of rising
costs and lower commodity prices as the main causes for recent
declines in prots. Take for example aluminium and nickel
producers these commodities have witnessed the most signicant
drop in prices since August 2011, and given their nature, are
known to incur very high operating costs:
UC Rusal reported a 91.7% drop in net prot for 2011 due to
rising costs and lower prices, with aluminium trading near its
marginal cost production3
Alcoa recorded a loss from continuing operations of US$193m in
4Q11. In 1Q12, the aluminium producer reported a 70% y-o-y
drop in income from continuing operations to US$94m4
BHP Billitons Stainless Steel Materials (nickel) business reported
a 99.7% y-o-y drop in earnings before interest and taxes for the
half year ended 31 December 2011,5 partially a reection of a
35% drop in nickel prices through 2011
In 1Q12, Vales nickel unit reported a 29% y-o-y decline in
operating revenue due to low nickel prices6

* Renamed from Cost management in 2011 as it better reects the inationary environment
1 Cost ination is major theme for metals production: Deutche Bank, Commodity
Online, 16 April 2012
2 Commodity prices spark Rio Tinto warning, Australian Broadcasting Corporation (ABC)
News, 28 November 2011 via Factiva (c) 2011 Australian Broadcasting Corporation
3 More pain looms for aluminium, The Australian Financial Review, 13 January 2012
4 1st Quarter Earnings Conference, Alcoa Quarterly Earnings Presentations, 10 April 2012
5 BHP Billiton Results for the Half Year Ended 31 December, BHP Billiton press
release, 8 February 2012
6 Performance of Vale in 1Q12, Vale nancial performance, 25 April 2012

20

The period of record-high commodity prices extended from 2H10 to


1H11, masking the real impact of rising costs, as the mining and
metals sector enjoyed large prots. During this period, mining and
metals organizations implemented signicant capital investment
plans and also increased production to cash in on the period of
premium pricing. As a result, the supply of raw material, labor and
equipment to the industry has tightened considerably, pushing up
operating and capital costs alike.

Capital cost ination without a concurrent increase in underlying


commodity prices is forcing industry players to revise their capital
expenditure targets. Large and small scale players, irrespective of
commodity, are succumbing to capital cost pressures and this is
likely to result in delays to new supply across all sectors within the
industry. This slowing of the supply response may help sustain
above average pricing and thereby attract more development.

Crude oil prices, wage ination and increasing complexity


drive operating costs
Operating costs continue to increase on the back of high crude oil
prices and wage ination. The cost of mining consumables and
transport is closely linked to the price of oil, which has been on the
rise since 2010. Oil prices continue to trade at around US$100/
barrel, and rising tensions between Iran and the Western economies,
together with supply concerns in Africa, present major risks to oil
prices in the medium term. Wage ination is also rife across the
sector, as employees seek to share the prots. Several mines across
the world were hit by labor strikes for higher pay in 2011, triggered
by the record-high commodity prices and near-record prots that
sector players experienced between 2H10 and 1H11.

7 AngloGold Ashanti Q1 Earnings Double to US$429m; Approves US$1.9bn Growth Projects,


Marketwire, 10 May 2012

The business risk report Mining and metals 20122013

Paul Mitchell
Global Mining & Metals Advisory Leader, Ernst & Young
Cost ination is a risk that keeps growing, and continues to threaten prot margins and the viability
of projects.

Operating environments for mining and metals companies are


becoming more complex, posing both physical challenges (deeper
underground mining, remote locations etc.) and political challenges
(safety concerns, regime instability etc.). More complex operations
generally mean more costly operations. While physical challenges
can be addressed by investing in expensive new technology and
infrastructure, political challenges bring with them increased and
constantly changing safety and environmental reporting, causing a
substantial increase in compliance costs.
Declining ore grades and consequently higher production costs are
a reality that several existing mines are struggling with globally.
Similarly, miners are going deeper underground as higher prices
allow a costly affair in comparison to traditional open pit mining.
So although the prots are there, the same margin is not being
realized.
Mining and metals companies are increasingly investing in new
regions as desirable mining projects become harder to nd.
However, much of this potential new supply is located in remote
areas a physical challenge that translates into even higher costs
than the general levels the industry is facing:
Consumables due to the lack of access to national power grids,
many remotely-located projects are forced to rely on diesel
generators to power their operations. Agnico-Eagle Mines
Meadowbank mine in Nunavut (Canada) uses up to 60m liters of
diesel annually, making energy one of its biggest cost pressures8
Labor mines located in remote areas struggle to hire and retain
skilled staff, with labor often cited by CEOs as a top cost pressure.
In order to attract and retain skilled labor to remote locations,
companies are forced to pay increasingly competitive salaries and
rely on y-in y-out labor pools.
Lack of infrastructure the lack of roads, rail, power, water and
other infrastructure adds to the development costs of mine
projects in remote areas. Additionally, costs specic to social
infrastructure are increasing

8 Canadas Nunavut awaits its day in the sun, Reuters News, 2 April 2012

The increasing costs and falling revenues of remotely-located


projects are threatening to make them unviable. For example, a
signicant number of upcoming and operating gold projects in
Canadas Far North region have been written-down partially or
shelved altogether for this reason. Growth strategies are
increasingly shunning the additional cost burdens of developing
greeneld projects in favor of browneld expansions at exiting sites
where manpower, resources and infrastructure are already in place.

The currency impact


Industry-wide cost ination is being compounded by strong
currencies in most resource-rich countries. Since late 2008, the
Australian dollar has strengthened by over 60% against the US
dollar; the currency global commodities tend to be priced in. The
Canadian dollar, Chilean peso, Brazilian real and South African rand
have all moved similarly. This has pushed up the relative cost of
wages, power and other local goods in these countries.

How is the industry responding?


Cost ination, in a period of softer commodity prices, is forcing
mining and metals companies to either re-evaluate, shutdown or
divest high cost and non-core business units. Several companies are
reviewing their portfolios to identify underperforming assets.
Energy-intensive aluminium is already witnessing multiple
shutdowns and closures in the industry. A number of companies are
opting to divest their downstream aluminium assets where China
has excess capacity, while retaining upstream assets where
demand, particularly from China, is expected to remain strong.
Aluminium major Alcoa has closed substantial volumes of smelter
capacity, while Rio Tinto is divesting parts of its aluminium
business.9 There has also been re-evaluation in the nickel sector,
with BHP Billiton cutting production and Kagara Mining entering
voluntary administration.10

9 Rio Tinto to divest US$8bn of aluminium assets, The Financial Times, 17 October 2011; Alcoa Sees
Aluminum Cuts as Production Gains: Commodities, Bloomberg, 10 April 2012
10 Western Areas buys Kagara nickel mine, The Australian, 2 March 2012; BHP to make rst job cuts
since GFC as nickel dives, The Australian, 2 February 2012

The business risk report Mining and metals 20122013

21

Rising costs are also driving consolidation within the industry for
synergies, economies of scale and greater negotiating power.
Larger companies tend to be in a stronger position to negotiate
better terms with contractors and suppliers. Interestingly, some
sector players are beginning to forge collaborative relationships
with their contractors and suppliers, with the aim to achieve greater
savings and increased productivity. For example, to identify
opportunities for waste removal from the supply chain, Vales
procurement team holds collaborative workshops not only with
other functions within the company, but also with suppliers. Vales
collaborate to innovate workshops have helped save costs worth
roughly US$500m over a span of just three years.11 The category
management approach is also gaining popularity with procurement
teams, whereby the relationship between a miner and its suppliers
moves to one of collaboration, rather than the traditional
adversarial relationship. Such an approach generally entails the
exchange of information, sharing of data and joint business
building, with common turnover, protability and cost-saving
targets that mutually benet the miner and supplier/contractor.
Companies are increasingly turning to technological solutions to
mitigate wage ination. The high cost of supporting a y-in y-out
workforce is pushing companies to invest in automation. Rio Tinto is

committed to this solution with plans to spend US$483m to make


its trains driverless, a decision that follows last years move to put
150 automated dump trucks into its Pilbara mines in Australia. The
companys automated production drills, loaders and haul trucks will
be supervised from a remote operations center in Perth. Rio Tinto
could save an estimated US$72m per annum, cut its workforce by
600 and reduce costs by 30 cents per tonne of iron ore if 50% of its
trucks are automated.12 Fortescue Metals Group and BHP Billiton
are also moving in the direction of driverless truck technology.
Companies are also focused on reducing energy-related costs by
investing in energy projects and even taking interests in power
assets. Furthermore, capital cost overruns have highlighted the
need for more robust systems to improve forecasts and project
controls. To lower their cost base, companies are increasingly
procuring equipment from developing countries. A switch to
owner-operated mines could also help companies save costs. BHP
Billiton has acquired part of Leighton Holdings HWE Mining division
to bring its Pilbara iron ore operations inhouse rather than hire
outside contractors. Discounting estimated contractor margins of
5% to 7%, the miners cost base in the Pilbara will reduce by roughly
US$55m to US$77m per annum (6090 cents per tonne of
iron ore).13

Steps mining
companies
and can
metals
takecompanies
to respondcan
to this
takerisk:
to respond to this risk:
Focus on sustainable cost reduction programs

Review of supplier contracts

Divestment in non-core assets

Outsourcing

Review of capital tied up in high levels of pre-stripping, advance


development and stockpiles

Creation of strategic joint ventures to optimize economies


of scale

Consideration of the use of contract mining vs. sale or leaseback

11 Procurement Teams Recognized for Innovation, MyPurchasingCenter.com, 28 September 2011

22

12 Rio high in an empty driver seat, The Age, 6 April 2012


13 BHP turns owner-operator in US$735m buy, The Australian Financial Review, 10 August 2011;
Completion of the Acquisition of HWE Mining, BHP Billiton press release, 30 September 2011

The business risk report Mining and metals 20122013

(same as 2011)

05

Capital project execution


The current period is shaping as a time of great opportunity,
and great challenge, for mining and metals companies delivering
major capital investment pipelines. A massive pipeline of
committed projects requires delivery during the 20122015
period. Competition for resources to execute remains as acute
as ever. Announced investments across the global mining and
metals sector totalled US$676b at the end of 2011 an immense
20% y-o-y rise.1 Mining and metals leaders are increasingly aware
of global macro-economic trends and are actively shaping their
delivery strategies accordingly.
These trends stem from heightened global economic volatility and
continuing delivery cost ination:
Uncertainty around the rate of growth in demand for metals and
energy from the growth engine economies
Uncertainty as to the price for key commodities, impacting
economic hurdle rates for capital investments
Uncertainty as to regulatory obligations impacting environmental,
labor and taxation requirements
Increasing delivery costs resulting in frequent and substantial
cost variances on recent capital projects
This uncertainty has been putting downward pressure on prices of
mined commodities since 2H11 and has placed emphasis on the
increased need for efcient project selection, planning and
execution to ensure good returns in times when margins are
already under pressure. Established producers have a vested
interest in moderating the supply response during a period of
premium commodity pricing for as long as possible rather than
supplying sooner but eroding their premium.

1 E&MJs Annual Survey of Global Mining Investment, 20 Jan 2012, www.e-mj.com

Commodity price trend


In view of the volatile macroeconomic environment, not only have
the new project announcements slowed in 2012, but mining and
metals companies are now reconsidering, revising and prioritizing
or sequencing previously announced capital project plans. About
47% of the mining and metals companies polled by Citigroup during
1Q12 are considering lowering their capital expenditure budgets,
compared with 18% that were considering lowering their budget in
4Q11.2 Companies are now exercising caution in laying out capital
expenditure plans:
BHP Billiton is reportedly revisiting the sequence of its capital
expenditure plans to maximize value and reduce risk as it faces
the prospect of lower cash-ow generation from its projects.
While the company is expected to reach a decision on several
major projects including Olympic Dam and Port Hedland in
Australia by the end of 2012, it is now unlikely that it will spend
the reported US$80b in capital expenditure by 20163
Rio Tinto has announced that it is carefully evaluating projects
and that some growth opportunities may not be developed4
Vales overall budget for capital expenditures on project execution
for 2012 is 12.9b, compared to US$17.5b in 2011. In view of the
risks associated with the execution of projects, the company has
said that it may revise the estimates of their projects expected
capital expenditures and estimated start-up dates5

2 Signs of Fatigue in the Commodities Supercycle, The Wall Street Journal, 23 May 2012
3 BHP Billiton pulls back from US$80bn spend, The Telegraph, 16 May 2012; BHP moves to ease
worries over mega project spend, Reuters, 2 May 2012; BHP Billiton tweaking capex plans, CEO says,
http://www.marketwatch.com, 15 May 2012
4 Rio Tinto reafrms condence in demand outlook , http://www.marketwatch.com, 9 May 2011
5 Vale announces investment budget for 2012, Vale press release, www.vale.com

The business risk report Mining and metals 20122013

23

The metals and mining community adapts


Leading mining and metals companies are adapting to emerging
capital project risks by raising the bar on business case justication,
prioritizing investment pipelines and enhancing the level of project
control expected of delivery teams.
Raising the bar on business case justication and rigor
Business cases are made or broken on the back of estimated
costs and benets and there is now a renewed focus on the
integrity of this data. Projects are being asked to declare
transparent estimation methodologies, benchmark against
historical performance and stress-test their numbers for a range
of anticipated delivery scenarios. Improved rigor in underlying
business case data substantially improves managements level of
decision-making condence.
Every project faces a unique array of delivery risks but not every
business case factors these in. Project teams that holistically
assess and, in turn, align contingency allocations to each projects
unique risk prole are ensuring business cases accurately dene
the likely capital outlay required. Clearly declaring underlying
assumptions and arranging peer review validation builds rigor in
business case planning. A key assumption, and risk factor, is the
impact of price volatility scenario modelling will identify the
critical price-points for future business case review.
Every business case needs an owner who can vouch for,
champion and be accountable for the delivery of the identied
benets. Companies that establish clear and single-point business
case ownership can align delivery performance with an
individuals key performance indicators (KPIs) and a business
units capacity and budget forecasts.
Prioritizing the investment pipeline to align with a changing
appetite for cost and cash exposure
Mining and metals companies are making the hard call to
prioritize their capital expenditure. As leadership teams develop
customized criteria to sequence their project pipeline,
prioritization considerations extend beyond return on investment
(ROI) to include strategic alignment, cash ow exposure and
delivery complexity.

24

The assessment of strategic alignment requires mining and


metals companies to determine how mega-project investments
align to the companys long-term (often multi-decade) business
plans. It is on this planning horizon that a broad range of strategic
considerations come into play, such as which projects:
Will drive performance against key analyst measures such as
US$/tonne, market share and reputational value?
Will establish the growth option infrastructure to support
business-building investments into the future?
Will support the diversication of risk, price and currency
exposure?
Are aligned to commodities that the company seeks to grow,
stabilize or exit?
Are aligned to the companys view of core business whereby
the owners team may be seen as an investment manager,
construction manager and/or operator?
Offer a superior value proposition to comparable acquisitions?
Have access to high performing and cost effective suppliers to
undertake design, fabrication and construction?
Will best leverage technologies suited to cost-reducing
engineering design, offshore module fabrication and access low
cost construction labor?
The projects that pass these tests will typically be sound
candidates to advance towards the front of the pipeline queue.
The assessment of cash ow exposure is particularly relevant as
leaders adopt an increasingly conservative decision-making bias
and seek to optimize liquidity. While mega-projects will be brought
forward on the merit of their individual business cases, many
companies will have a diminished appetite for running multiple
cash-intensive investments in parallel and some will seek to
actively decelerate expenditure rates. Increasingly, cash-intensive
mega-projects will be advanced in series and projects with long
ROI payback periods will face critical review.
The assessment of delivery complexity considers alignment to
existing company capacity, capability and proven technical
solutions. Innovation will continue to play a critical role in
improving efciency and effectiveness; however, this will be
balanced against the predictability of proven solutions. Similarly,
browneld expansion projects (where there is proven cash ow
from an existing asset and existing operational infrastructure),
may be advanced in favor of greeneld development options.

The business risk report Mining and metals 20122013

Claus Jensen
Advisory Partner, Ernst & Young Oceania
The focus is shifting from a rapid increase in production capacity to careful evaluation of capital projects
in an environment of heightened volatility.

Enhancing project controls to drive standardized delivery


against plan
Having put forward robust business cases, and effectively
prioritized capital expenditure, project teams must embed the
right project control disciplines to not only drive delivery against
plan, but to do so in a standardized and consistent manner.
In light of the rapid labor and equipment cost ination facing
delivery teams globally, the objective of these project controls is
not necessarily to reduce absolute cost rather, project controls
emphasize thorough planning, and controlled change and
performance accountability to deliver predictable outcomes.
Financial predictability of the results generated from capital
investments is the ultimate strategic objective of any corporation.
However, this can only be achieved when projects apply proven
value engineering initiatives, are subject to stage-gated
independent review against business case requirements, and are
controlled by robust cost, schedule, risk and interface
management processes and tools.
Well managed projects invest in upfront planning, leverage and
standardize leading tools and processes, and are governed with
an emphasis on timely and informed decision-making. Roles and
accountabilities are agreed between project, program, owner and
contractor teams with a quantitative focus on performance
monitoring. To embed these practices across their project
portfolio, many leading companies have developed independent
project and program delivery teams, separate from the
underlying asset, whose specic mandate is to drive project
management enhancement.

Key value initiatives gaining traction across the mega-project


landscape include program-level delivery optimization and
strategic third-party engagement. Program-level optimization
identies cross-project synergy opportunities including
standardization, replication, continuity and scale-driven leverage.
Strategic third party engagement drives mutual and sustainable
commercial value by aligning category planning, vendor
selection, contracting model conguration (including EPC/EPCM
models) and incentivization frameworks to the requirements of
the project delivery environment. Moreover, they apply
sophisticated approaches to allocating associated risk and
rewards to the contracting entity best placed to manage project
delivery risks. Additionally, innovations such as equipment
automation and the remote control of certain mine operations
from a distant location are increasingly being explored across the
sector as further avenues to realize project and operational value.
Stage-gated reviews provide a periodic interval to assess progress
against plan and formally approve progression to the next project
phase (including release of associated funding). While continuing
to provide an opportunity to review lessons learnt and revise
next-phase planning, a cost-centric management agenda will
drive particular focus on phase-by-phase performance against
budget and benet realization plans. Projects that demonstrate
signicant variance against plan are increasingly likely to face
substantial corrective planning or the potential of discontinuation.
A similarly focussed approach should be anticipated for material
change requests and contingency draw downs.

Steps mining and metals companies can take to respond to this risk:
Rigorous portfolio management and greater scrutiny around
project selection, prioritization and management is vital
Operationalize knowledge management through incorporating
learning, technological advancements and benchmarks into all
procedures and databases
Implement an effective risk management process where there is
a clear line of sight between project, portfolio and strategic risk
management such that objectives are supported by appropriate
tactics that address all potential project threats

Ensure project and supply chain performance is monitored and


managed by aligning owner and contractor teams alike through
pragmatic contracting strategies and incentive programs
Implement advanced assurance frameworks that provide
independent review and oversight over project performance.
This helps to proactively identify and manage challenges before
they become issues

The business risk report Mining and metals 20122013

25

(down from 4 in 2011)

06

Social license to operate


The value of reputation
It is widely recognized in the sector that maintaining a license
to operate is not just a compliance exercise, but a way of doing
and growing business. It has further evolved in recent years to
become a vital competitive advantage for many companies. A
strong reputation and consistent history of maintaining this social
license to operate is vital.
Mining and metals companies are nding that by being known as
a company that does the right thing by all stakeholders makes it
easier to access new projects and raise capital, which is valuable for
small companies in current times. Additionally, such a reputation is
invaluable in establishing trust when dealing with communities,
non-government organizations, and current and future employees.
Reputation is also vital with host governments which are
increasingly communicating with each other. Thus keeping ahead
on community and sustainability issues is a vital competitive edge,
as poor legacy decisions can have detrimental long term impacts.

mining companies operating in the country whereby the miners


agreed to pay a 9% tax rate in the years 2010, 2011 and 2012,
instead of a xed 4% rate of operating prots. The increased tax has
given the Chilean Government access to additional funds needed
for the reconstruction following the earthquake in 2010.1
Also, stakeholders, especially indigenous communities, are
increasingly expecting greater benets from mining and metals
companies operating in their regions other than pure economic
benets such as employment. Governments and communities are
also becoming more sensitive to social, political and environmental
issues and their expectations of baseline social license to operate
practices have now increased. For instance, companies which have
been operating mines in partnership with the government in
emerging regions for some time are being challenged to increase
their value to the local community with the next generation of the
government which perceives previous best practice as the new
norm and are looking for improvements.

Acquisition challenges
Increased expectations
Mining and metals companies are nding social license obligations
increasingly expensive both due to higher expectations and the
costs of the community partnerships. Costs are rising not only
in terms of actual payments, but also in the time and money
involved in developing appropriate agreements. For smaller
companies and explorers, these negotiations and costs can be
especially challenging.

Acquisitive mining and metals companies are challenged by the


often lower standards of target operations, and understand the
need to build trust with the local communities when moving into
new geographies. Being a new entrant moving into an established
geography through acquisition, or having to address the legacy
issues left by the previous owner, present signicant challenges,
potentially leading to commercial and nancial issues. There are
numerous examples of this:

A variety of political groups and non-government organizations that


are concerned by the impacts of mining and metals production are
agitating for a variety of outcomes, from a ban on all mining to
greater distribution of wealth. Both legitimate complainants and
political activists know that the signicant margins that mining and
metals companies have been earning recently increases their
urgency to settle disputes in order to maximize production sold into
this period of premium pricing. Protecting reputation by being
reactive can therefore be high risk and very expensive.

Companies acquiring operations in developing geographies, for


example, where the previous owner has had less rigorous
approaches to bribery, environment, health and safety of the
workforce and community and needs to quickly change
expectations on how business is conducted

To stay ahead, companies have to be proactive in their dealings


with communities and governments. Speed is important as it
prevents a potential issue becoming political. For example, in Chile
in 2011, a deal was struck between the Government and the large

Where a state owned enterprise or other foreign mining and


metals company acquires a mining and metals operation in a
developed or other country, and there is potentially distrust and
preconceptions regarding the standards at which the company
will operate

Where a company (however good its reputation) acquires an


operation that has had a record of poor environmental
management, legacy health issues etc. and has signicant
community resentment towards the operation

1 Chilean miners opt for new tax regime, Platts Metals Week, 24 January 2011

26

The business risk report Mining and metals 20122013

Helen Adair
Executive Director, Climate Change and Sustainability Services
Social license to operate has been ranked as a top six risk over the last ve years as it represents a
consistent long term challenge.

The acquiring company needs to move quickly to set a clear tone


and expectation of how business will be conducted moving forwards
and signicant efforts need to be invested in building relationships
with the host communities and governments. This requires mining
and metals companies to be especially transparent with both
communities and governments to develop trust and build long term
sustainable partnerships.

Changing how business is done


Mining and metals companies are changing the way they engage
with stakeholders, such as communities and non government
organizations. Historically, they took a very technical response to
an emotive issue, something which often worked to their detriment.
Companies are increasingly employing specialists to liaise with
communities and a number of these specialists are previous
activists themselves. This means they are better equipped to deal
with potential community outrage which can prevent major project
approvals and frequently occurs as a result of not dealing with
peoples emotions, concerns and fears.2

Companies are now viewing their interactions with stakeholders,


especially communities, as partnerships and this approach of
strong engagement can be vital to success. For example, Teck
Resources has changed how it enters a new region by ensuring it
has no pre-existing plans before talking to local stakeholders. The
company now only develops plans for a project after it has met with
the community and develops these in conjunction with this
community.3
This partnership approach fosters a relationship of trust and buy-in,
something which is crucial for operating harmoniously in a
community. Key to building this trust is transparency and clarity
around the monitoring and reporting of company activities so the
community has faith that the organization is doing what it says it
will. For example, Barrick Gold employs community members to
carry out the monitoring of water discharged from one of its mine.
This both empowers the community and builds trust, creating a
stronger partnership.4

Steps mining companies are taking to respond to this risk:


Incorporate risks to the social license to operate into the
enterprise risk management framework with clear and proactive
risk mitigation strategies

Link sustainability outcomes to attraction and retention of the


workforce

Embed these mitigation strategies in all critical business


processes to ensure that an integrated approach is adopted

Encourage trusting and supportive relationships with all


stakeholders to reduce security risks in troubled locations

Encourage and engaging in community/employee debate over


sustainability priorities

Integrate sustainability objectives into all long-term planning

Improve speed to act on potential license issues

Integrate sustainability key performance indicators (KPIs) with


productivity outcomes often in remuneration structures, e.g.,
increase in mine safety, reduction in water consumption and
waste etc

2 License to chill, AFR Boss, April 2012

3 ICMM hosts CEO Panel at PDAC International Convention, YouTube video, 17 April 2012,
http://www.youtube.com/watch?v=ulDfE3GYm8w. Accessed 13 June 2012
4 ICMM hosts CEO Panel at PDAC International Convention, YouTube video, 17 April 2012,
http://www.youtube.com/watch?v=ulDfE3GYm8w. Accessed 13 June 2012

The business risk report Mining and metals 20122013

27

Prospects and perils:


facing up to political risks in mining
and metals
By Jean Devlin and Gemma OLoghlen at Control Risks
The mining and metals sector bears the brunt of the
political risks that come with operating in complex
environments. With limited exibility over where to
access resources and a huge volume of upfront
investment needed, understanding and managing
these risks is crucial if a mining and metals investment
is to remain on track and achieve the results
demanded by investors.
Over the past year, the quintessential political risks
nationalization, coups and outright conict have
occurred in several mineral-rich countries. The coming
12 months present a worrying landscape: complex local
politics, regional power struggles and conicts in mining
will play out against a broader backdrop of a protracted
Eurozone crisis, a weak global economy and a US
presidential race. When uncertainty is the only
certainty, knowledge and the ability to analyze external
events are key defenses in guarding against any
negative impacts on mining and metals investments.

Whats mined is mine


In the mining and metals sector, political risk has
become almost synonymous with resource nationalism.
Examples abound of governments robustly asserting
national interest in extraction over the past year: local
beneciation in South Africa, export restrictions in
Indonesia, increased royalties and taxation in Canada
and Zambia, and compulsory government stakes in
Guinea. This is undoubtedly a signicant risk for mining
and metals companies, and in extreme cases has the
potential to wipe out any expected gains from a project,
making it one of the principal trends to monitor.

Even drastic measures such as expropriation and tax


hikes are easier to handle when they can be predicted,
and when governments are rm but sensible
communicators. The most difcult challenges arise
when policymakers act unpredictably, such as in
Zimbabwe or Venezuela, taking decisions that yield few
tangible benets to government or organizations.
Predicting how such players will act is no easy task, but
there are some questions that organizations can ask to
determine how likely they are to be affected by any of
these sorts of government policy changes:
Is it simple rhetoric or are there signs or past
behaviors that indicate a will and ability to
change policy?
Are elections looming? Is any policy change likely to
gain favor with the voting public?
Is there popular support for any changes?
Are there individuals with the intent and capability to
act who would gain from the move?
What is the state of government nances? Could high
commodity prices prove irresistible to a cash-strapped
government?
The debate currently raging over the ANCs State
Intervention in Mining Sector (SIMS) report in South
Africa underlines how crucial this trend will be over the
next year and, as a regional bellwether, makes South
Africa an important market to watch.

Editorial
28

The business risk report Mining and metals 20122013

Polling time
Elections and the promises made during campaigns
often create policy uncertainty for the sector. The sheer
number of polls scheduled in countries with both an
established and emerging mining and metals sector this
year places electoral politics at the heart of political
risks to watch (see map). Mongolia, where investment in
the emerging mining and metals sector is transforming

an otherwise underdeveloped economy, held


parliamentary elections on 28 June 2012. The
importance of foreign investment is generally
recognized by all parties, but promises of
nationalization have become an easy way to win
popular support. The countrys recently introduced new
foreign investment law reects this populist element in
policymaking.

Ukraine
Mongolia

Romania
United States
Mali
Mexico

Mauritania
Burkina Faso

Philippines
Togo
Congo

Venezuela
Ecuador

Guinea

Ghana
Sierra Leone

Papua New
Guinea

Kenya

Angola
Zambia

East Timor

Malaysia
Madagascar
Zimbabwe

Counting ballots
General or presidential elections are scheduled in an array of important mining markets, including the United
States. In sub-Saharan Africa they include the regional mining giants of Guinea, Ghana, Zambia and Zimbabwe,
along with lesser players Angola, Burkina Faso, Congo (Brazzaville), Kenya, Madagascar, Mali, Mauritania,
Sierra Leone and Togo. In Latin America, Mexico, Venezuela and Ecuador will all host polls, while in Mongolia,
Papua New Guinea, Timor-Leste, Malaysia and the Philippines will vote in Asia. Mining and metals hubs in
Europe set to cast ballots include Ukraine and Romania.
Source: International Foundation for Electoral System calendar, media sources

The business risk report Mining and metals 20122013

29

Viewed in a positive light, the increased bargaining


between governments and the population through
elections are welcome signs of maturing democracies.
Yet expectations of social and economic development
are directed not only at national governments, but also
at prominent investors. Even when polls occur
without violence or disputes, disruption will follow
if development dividends are seen to be lacking.
Perus presidential elections in 2011 ran peacefully, but
widespread frustration with inequality has been fuelling
social unrest and labor strikes in 2012. Indigenous and
community activism at mining projects, some of which
have resulted in violence or the temporary suspension
of operations, demonstrate how disruptive unmet
expectations can become. Tackling such widespread
unrest remains President Ollanta Humalas greatest
challenge. The experience of investors in Peru and
elsewhere underlines how foreign multinationals can be
caught in the crossre of complex local politics and
may even be targeted. Local leaders may be tempted to
support opposition to a mining and metals project for
their own political gain, as well as to extract concessions
from central government.
At its most extreme, unrest can spiral into political
violence, as seen in Cte dIvoire in 2010 and Mali in
2012. This is not only destabilizing for operators within
those countries, but also affects the stability of the
wider region, which holds huge promise in deposits.
Malis military coup in May 2012 was followed by
political turmoil in the capital and left a power vacuum
in the northern hinterland, now lled by an assortment
of domestic rebel movements and regional jihadi
groups, including al-Qaida in the Islamic Maghreb.
Although gold mining activities are concentrated in the
south of the country, which is less directly affected by
the crisis, operators in Mali have seen their share prices
hit by the scare factor and premiums rise on external
nancing and insurance. In addition, government
distractions are causing greater bureaucratic
bottlenecks. The status of a new mining code that was
due to be enacted prior to the crisis is unclear, and
operators are experiencing signicant difculties with
the import of equipment and other routine procedures.
The turmoil gives rise to the prospect of security threats
moving southward or crossing borders into neighboring
Niger and Burkina Faso, placing strain on their security
environments.

30

Tightening regulations
Aside from new anti-corruption legislation, there is a
proliferation of regulations and standards governing the
environmental and social impacts of mining and metals
activities. These range from national level legislation
and international project nance standards (such as the
Equator Principles) to international restrictions on trade
in conict minerals (notably those set by the OECD), and
non-statutory expectations of human rights impacts
(such as the Voluntary Principles on Security and
Human Rights). These instruments generally seek to
improve the transparency and effectiveness of the
sector, often giving welcome guidance, but can be
complex and time-consuming to absorb into operations.
For instance, in Indonesia, increasing devolution of
regulation to local administrations multiplies the
number of political actors with whom organizations
need to interact. In the worst case, legitimate efforts
at improving the sector can be used by unscrupulous
parties to exercise inuence for political ends. The
experience of mining and metals companies at the
hands of regulators over alleged violations of
environmental and other conditions notably in Russia
several years ago can leave lasting impressions on
foreign companies seeking to do business in a country.

Upsides
It is easy to view political risks as bringing only negative
consequences, but there can also be positives that are
not immediately evident. For the mining and metals
sector, what are currently viewed as downside risks
resource nationalism or increasing regulation for social
and environmental impacts over the long term may
produce positive results, by making the sector more
transparent and ultimately strengthening the capacity
of countries of extraction to manage social expectations
and engender long-term development.
A recently-launched review of Cte dIvoires mining
code points to improvements in the investment climate
for operators there in 2012 and 2013. Anti-mining
sentiment in the early post-independence period and
instability during the 1990s and 2000s dampened
investor interest in the sector. However, the gradual
normalization of the political and security environment
following post-election conict in 201011, and
President Alassane Ouattaras desire to place foreign
investment at the heart of the countrys post-conict
recovery, has opened up new opportunities for mining

The business risk report Mining and metals 20122013

and metals companies for the rst time in decades.


The relative lack of institutional knowledge of the
mining and metals sector which has rendered market
entry and permit negotiation processes slow and
problematic can be expected to improve with the
review process rmly in the charge of the president.
The Governments most technically competent gures
are among Ouattaras immediate advisers. The code is
likely to be re-drafted and passed by September 2012.

through Codelco, the state owned copper company. The


countrys track record has demonstrated good
protections for foreign investors in a region little known
for such behavior. Meanwhile, Botswanas effective
management of its diamond wealth since the rst big
discovery was made one year after independence has
made it a beacon of stability in a troubled region, and
proves the case that mineral resources can be
harnessed for long-term development.

Chile is a country that has managed to build up a strong


mining and metals sector in the past two decades and
attracted signicant outside investment even though
the government retains a major stake in the sector

For now, however, irrespective of the jurisdiction, the


greatest certainty remains that when it comes to the
mining and metals sector, politics is business and
business is politics.

Steps mining and metals companies can take to respond to this risk:
Mining and metals companies are increasingly aware
of the need to understand their political risk exposure
before considering investments, as well as in response
to sudden developments. The level of detail required
and the need for forward-looking analysis depend on
the stage of investment and the perceived stability of
the country or area in question. Risk assessments are
often carried out in conjunction with other studies that
are required as a matter of course by the industry (for
example, environmental and social impact
assessments (ESIA), and community or social
stakeholder engagement studies). Others focus on a
rolling assessment of developments and related
impacts on assets or commercial activity.

Some key tools available to mining and metals


companies include:
Country-based assessment of political risk
Multi-country benchmarking assessment
Stakeholder or power mapping to understand
spheres of inuence and links between politics and
business at a country, regional or local level
Project-level risk assessments of newly acquired or
potential assets (due diligence)
Issue and event monitoring political, regulatory
and social developments that may impact on
existing or future investments

Control Risks is an independent, global risk consultancy specializing in political, security and integrity risk.
We help our clients understand and manage the risks of operating in complex or hostile environments.
Established in 1975, Control Risks unique combination of services, geographical reach, extensive experience
and client partnerships allow us to deliver solutions to address specic issues, identify new opportunities and
monitor global developments that have an impact on our clients and their commercial activities.

Editorial
The business risk report Mining and metals 20122013

31

(down from 6 in 2011)

07

Price and currency volatility

The equity market has also not kept pace with metals prices. When
indexed against the Philadelphia Stock Exchange (PHLX)4 and
AMEX Gold Basket of Unhedged Gold Stocks Index (HUI)5, it is
evident that although gold prices have continued to rise, equities
have not. Between July 2008 and May 2012, gold prices increased
66%, vs. HUI which fell 9% and PHX which fell 22%, despite HUI and
PHLX increasing by 11% and 9% in the last half of May as compared
to bullion increasing by only 1%. In the latest Ernst & Young Capital

1 Gold investment statistics commentary: price, volatility and correlation performance during 2011,
World Gold Council, January 2012
2 Mergers, acquisitions and capital raising in mining and metals: 2011 trends 2012 outlook,
Ernst & Young, February 2012
3 EYeSight on Consolidation: Backpedalling on the cycle, Ernst & Young, November 2007
4 Top ten constituents as at 10 May 2012: Barrick Gold Corp, Freeport McMoRan, Goldcorp,
Newmont Mining, Yamana Gold, Silver Wheaton Corp, Kinross Gold, Agnico-Eagle, Compaia de Minas
Buenaventura, Anglogold Ashanti. Source: https://indexes.nasdaqomx.com/pdf/pdfreport.
ashx?IndexSymbol=XAU
5 Top ten constituents as at 10 May 2012: Barrick Gold Corp, Goldcorp Inc., Newmont Mining Corp.,
Yamana Gold Inc., AngloGold Ashanti Ltd., Randgold Resources Limited, New Gold, Gold Fields Ltd.,
Harmony Gold Mining Co. Ltd., Agnico-Eagle Mines Ltd., IAMGOLD Corp., Compania de Minas
Buenaventura S.A. , Coeur DAlene Mines, Hecla Mining Co., Allied Nevada Gold, Kinross Gold Corp.,
Eldorado Gold Corp. Source: http://www.nyse.com/about/listed/amex_components.html?ticker=hui

32

160.0
140.0
120.0
100.0
80.0
60.0
40.0

HUI

PHLX

5/3/2012

4/3/2012

3/3/2012

2/3/2012

1/3/2012

12/3/2011

11/3/2011

9/3/2011

10/3/2011

8/3/2011

7/3/2011

6/3/2011

5/3/2011

4/3/2011

20.0

3/3/2011

The range of analysts metals forecasts is getting wider and more


cautious and there is a trend developing of forecasts being
consistently below actual prices. We can track this trend back to
2007 when we observed the mining companies, by their actions,
have made a clear statement that they believe in medium to
long-term metals prices and that even though condence in the
sector increases with each acquisition announced, our analysis has
shown that historic predictions of metal price forecasts have lagged
actual spot prices by signicant margins.3

Gold price vs. HUI and PHLX index

2/3/2011

Stock market volatility tested the condence of many mining and


metals companies to undertake M&A during 2011. The equity
markets are becoming increasingly sensitive to global and regional
macroeconomic news, and for many organizations, market values
do not appear to be correlated with the value of the minerals under
the ground. Increases in commodity prices are often not fully
impacting share prices, whereas decreases are. The erosion of the
gold premium is a prime example. This is creating differing asset
valuation expectations, impacting the ability to complete
transactions.2

Condence Barometer, the mining companies interviewed indicated


a dramatic drop in their condence in the short term market
stability,6 which is perhaps mirrored in investor condence.

1/3/2011

Price and currency volatility comes in many forms and falling


demand is not the only factor currently driving volatility in the
market. Metals prices experienced increased uctuations in 1Q12
vs. 1Q11 as investors reacted to the US and Eurozone sovereign
debt crisis, as well as slowing levels of activity in the high growth
economies of China and India. With the large number of exchange
traded commodity funds and products, metal prices have come
under pressure due to prot-taking, rebalancing of portfolios and
margin calls.1

Gold

Source: Thomson Datastream, Ernst & Young analysis

Foreign exchange volatility is experienced when an organizations


operating costs are not in its functional currency. For organizations
with a substantial portion of their revenue and debt denominated in
US dollars, uctuations in exchange rates can have a large impact
on their bottom line, especially when the cost of goods sold is
denominated in local currencies. For example, Vale reported
currency losses of US$1.382 billion in 2011 due to the impact of
exchange uctuations in the cost of goods sold in local currencies in
a broad range of jurisdictions in which they operate, including Brazil,
Canada, Australia and Indonesia.7 In some jurisdictions, currencies
demonstrate a negative correlation to metal prices. For instance, in
Chile, where copper is predominantly mined, the correlation
increases cost volatility to some extent. As such, currency can be a

6 Capital Condence Barometer mining and metals data, Ernst & Young, April 2012
7 Vale S.A. Form 20-F, United States Securities and Exchange Commission, 17 April 2012

The business risk report Mining and metals 20122013

Jay Patel
Transactions Partner, Canadian Mining and Metals, Ernst & Young
Current global issues will fuel uncertainty and therefore volatility. Successful miners will be those that
recognize and exploit value from volatility.

natural hedge against metal price movement and companies need


to consider not just a metal price hedging strategy, but also a
currency hedging strategy that may have an inverse relationship.

What companies can do to hedge or not to hedge?


Some of the larger mining and metals companies believe that the
diversied nature of the commodities they produce provides some
protection to price and currency volatility. Most large mining and
metals companies do not engage in commodity price hedging,
although some hedging may be undertaken for strategic reasons.
For example, Thomson Reuters GFMS forecasts an on-going low
level of hedging among gold producers, after a 2010 trend towards
de-hedging was marginally reversed in 2011. The producer hedge
book increased for the rst time in a decade, with 18.0 tonnes8
of hedging added to an estimated outstanding global hedge book
of 158 tonnes.9
The gold mining sector is deriving clear benets from a decade of
rising prices and high absolute prices, giving producers a healthy
pipeline of new projects coming on stream, and this also means that
several mature operations are staying productive for longer than
would otherwise have been the case.10 While, in general, larger
miners seem to be shying away from hedging, junior and mid-tier
miners will use contingent payments (directly or indirectly linked to
commodity prices) to grow their portfolio through acquisitions or
when raising debt nancing. AuRico Golds divestments announced
in 1Q12 reects this trend.11 AuRico Gold has two divestments.
Both have a portion of the proceeds contingent on future cash
ows. So in essence, the buyer has hedged its metal price risk by
agreeing to pay in future only if cash ows meet certain thresholds
(and cash ows are directly impacted by metal price), while the
seller has not given up any upside should prices continue to rise.
Needless to say, debt providers prefer hedging in order to reduce
their downside risk.
Mining and metals companies should consider hedging inputs to
production. Barrick Gold successfully applied this strategy by
hedging its energy needs when it acquired an interest in oil and gas
company, Cadence Energy, in 2008. The organization mitigated the

8 Includes forwards and delta-adjusted option positions


9 Gold Demand Trends: full year 2011, World Gold Council, February 2012
10 GFMS predicts gold prices will exceed US$2,000/oz by 2013, Mining Journal, 13 April 2012
11 AuRico Gold updates guidance: update follows recently announced divestitures of non-core assets,
AuRico Gold press release, 15 April 2012

impact of higher oil prices through the use of nancial contracts


and production from Barrick Energy, as it is now known, such that a
US$10 change in West Texas Intermediate (WTI) crude oil prices
would impact 2012 total cash costs by less than US$1 per ounce.
Barrick Energys contribution, along with the nancial contracts,
provides hedge protection for approximately 80% of expected 2012
fuel consumption. Production from Barrick Energy is expected to
continue to provide long term natural offsets to changes in energy
prices. Throughout 2011, Barrick Energy completed three
acquisitions, acquiring additional producing assets, reserves, and
facilities to allow them to grow and expand their energy business,
as well as continue hedging energy costs.12

Decision making in volatility


The greatest asset that any mining and metals company can have
during periods of great volatility is exibility in their operations. By
exibility, we mean the ability to quickly, and at relatively low cost,
vary the level of production. This exibility can be reected in
exible stafng, exible maintenance scheduling and exible supply
chains, for example. The existence and value of this optionality is
recognized by mining and metals companies, but rarely quantied.
While Discounted Cash Flow (DCF) modelling has historically been
the go-to valuation technique for mining and metals, its limitations
are becoming increasingly apparent during the turbulent economic
times we now face. Dynamic DCF and Real Option (RO) modelling by
mining and metals companies are providing decision-makers with
enhanced cash ow models that improve economic analysis, risk
assessment, management and nancing of mining projects. Interest
in these more sophisticated evaluation tools is being driven by a
number of factors.
Overall, global economic uncertainty is creating dramatic volatility
and uncertainty in metal prices, energy prices, interest rates and
foreign exchange rates, which in turn is changing risk appetites and
increasing investment hurdle rates. Additionally, a greater focus on
organic growth is requiring management to better understand the
relative risk of different capital allocations. A further factor driving
the need for better evaluation tools has been the rapid development

12 Barrick Gold fourth quarter and year-end report 2011, 16 February 2012

The business risk report Mining and metals 20122013

33

of mining projects in frontier economies, where the use of a single


discount rate for an investment with a 15 to 30 year time horizon
can produce misleading economic analysis, particularly if a projects
risk characteristics change erratically over its life.

discontinuing certain exploration and development programs. This


could lead to an inability to decrease costs in an amount sufcient to
offset reductions in revenues, and they may incur losses. Enhanced
scenario planning skills will become increasingly critical over time.

While the advances in nance theory and risk management behind


DCF and RO modelling have been around for a number of years,
they are only now beginning to be used more widely in public
technical reports, in economic analysis by corporate business
development groups, and for asset value calculations in nancial
reporting.

Need for increased corporate governance

These enhanced cash ow modelling techniques are not the


ultimate solution, but they can improve investment, nancing, and
risk management decisions and so should be considered part of the
corporate nance toolkit. While these tools provide decision-makers
with a richer description of project uncertainty, economic analysis
and risk assessment of mining projects, management and boards
are yet to arm themselves with these additional tools on a
consistent basis. Only a handful of mining and metals companies
are implementing these techniques in an organized manner. Mining
and metals companies generally seem to be battling with scenario
planning when it comes to future investment decisions and volatile
prices may cause inertia because it is hard to make decisions.
However, increasingly the recognition of sustained volatility requires
mining and metals companies to nd new techniques.
The adoption of more mark to market accounting standards has
meant that volatility in currencies and metal prices now translates
into volatility in earnings. An extended decline in the market prices
of commodities could also adversely affect company nancial
results, their ability to repay debt and meet other xed obligations,
and depress the trading prices of common stock and of publicly
traded debt securities. Additionally, if market prices for mining and
metals companies produce a decline for a sustained period of time,
they may have to revise operating plans, including curtailing
production, reducing operating costs and capital expenditures, and

With the increased focus of corporate boards on enterprise risk


management, we expect to see increasing board level focus on
currency and metal price volatility strategy and management. This
has boosted the number of companies assessing worst case and
best case scenarios for metals prices which could help companies to
develop multiple scenarios around investment decisions and capital
optimization, which is part of their Capital Agenda.13 The key here
is a balance in perspective to prepare for the worst while being
nimble enough to exploit the best.

Outlook
Global market dynamics from a slow recovery and a recession will
result in ongoing commodity price and foreign exchange volatility.
Currency movements will continue to be inuenced by everchanging speculation about the relative strength of different
economies. If the situation in Europe continues to deteriorate, then
commodity currencies will likely continue to devalue and the US
dollar should strengthen further. If fears of European debt problems
recede, the Chinese economy continues to grow strongly and the
US economy continues to improve, then commodity currencies will
likely start appreciating again as commodity prices rally. In the
interim, companies need to consider various strategies to reduce
the negative impacts of volatility to maintain predictable cash ow.
While volatility is generally perceived as negative, managing it
through an effective strategy and a management action plan is
imperative. The more successful mining and metals companies in
the future will be those that prove they can recognize and exploit
value from volatility.

Steps mining and metals companies can take to respond to this risk:
Identify sources of volatility that can be effectively managed
input prices, currencies and metal prices

Reassess hedging as a strategy to ensure nancial performance


no matter the direction of metal prices

Pursue hedging strategies to reduce currency and inputs


volatility to maintain predictable cash ow

Maintain a focus on costs and containing costs

Increase exibility in operations and measure the benets

Exercise prudence in capital allocation and performing stress


testing with extreme price assumptions

Undertake planning under various scenarios, even at a high


level, to assess the ability to withstand price shocks and the
ability to capitalize on the current metal price cycle

Diversify metal portfolio and jurisdictions to mitigate the impact


of a fall in prices of various metals and currency effects on
local costs

Put in place and maintain adequate liquidity arrangements for


downside protection

13 http://www.ey.com/Publication/vwLUAssets/Board_Matters_Quarterly_Issue10_Dec2011/$FILE/
Board%20Matters%20Quarterly%20-%20Issue%2010%20-%20December%202011.pdf

34

The business risk report Mining and metals 20122013

(down from 7 in 2011)

08

Capital management and access*


Boards in 2012 are facing an extremely complex and uncertain
environment within which to undertake capital allocation
decisions. Demand patterns are changing and unpredictable.
Cost ination is escalating, while commodity price assumptions
remain highly volatile, with an inevitable impact on the outlook
for company earnings. Resource nationalism, our number one
risk, is challenging boards around their acceptable degree of risk
and return. Pressure to increase short term return of capital to
shareholders is rising. And in May 2012, two of the industrys
largest companies, Rio Tinto and BHP Billiton, indicated that they
are beginning to revisit their capital investment programs.1 All of
these factors have brought the dilemma of build, buy or return
to the fore front again.
The risk of sub-optimal allocation of capital can have a signicant
and long-lasting impact. Today, mounting scrutiny over returns and
increasing competition for diminishing assets and resources
(people, services and equipment) is making capital management
increasingly complex and critical. The challenge for mining and
metals companies is to remain true to long term strategy, while
building in exibility to respond to short/medium term opportunities
and risks.

Capital allocation
Effective capital management involves the allocation of capital
resources in a way that best exploits a companys core
competencies and the market opportunities. The macro-economic
backdrop and outlook (such as expected commodity demand and
availability of capital) inuence these choices.
Rising metals prices, encouraged by Chinas rapid industrial growth,
along with cheap debt afforded the pursuit of mergers and
acquisitions (M&A) (buy) over the period to 2007. The global
economic crash of 2008 refocused attention on preserving balance
sheet strength including de-leveraging through rights issues, and
conserving cash. The 2H 20092010 recovery in prices was met
with a more cautious approach to growth. Large-scale M&A,
perceived to be high risk and difcult to execute, was largely
replaced by an overwhelming focus on capital expenditure (build)
that would see an estimated US$200b invested by just ve of the
industrys largest companies into organic growth programs over
the next ve years.2

* Renamed from Capital allocation in 2011 to better reect the broader environment which includes
both capital allocation / management and access
1 BHP Billiton, 2012 Global metals, mining and steel conference audiocast, 15 May 2012; Rios
capital costs global problem, Sydney Morning Herald, 3 May 2012
2 Miners: they think its all over?, Liberum Capital, 14 May 2012

By the end of 2011, companies were reporting record earnings.


Cash owed in, and dividend and share buyback programs
(return) were reinstated, though not at the expense of balance
sheet integrity. The major producers exploited favorable debt
market conditions in 2011 and 2012, undertaking bond buybacks,
renancing on cheaper terms and extending debt maturities. As a
result, industry gearing remains near an all-time (and, arguably,
sub-optimal) low of around 20%. However, this macro-economic
backdrop is perhaps more volatile than ever before.

The valuation gap


With the producers ostensibly in a position of nancial strength,
there is a growing valuation gap that appears to indicate the
market is not pricing in the scale of the industrys growth options.
Forward PE ratios for the top ve diversieds, for example, are
trading at around 7x, compared with their peak of over 25x
pre-2005 as earnings potential in the context of a growing China
began to dawn. Forward PE ratios of the mid-tier producers are also
down, by around 50% from 2006 levels, despite the diminished
leverage risk in 2012.
One possibility is that the market lacks condence in the
sustainability of industry-wide pursuit of organic growth. Fears that
miners are building at any cost, with the implied impact on the
levels of free cash ow available for return to shareholders and
potential oversupply of certain metals in the short-to-medium term,
perhaps explains some of the destruction we have seen in equity
valuations over the past 12 months. Some analysts speculate that
a focus on capex discipline, and a rechanneling of cash toward
dividend increases and capital returns, would drive a re-rating of
the industry. These depressed equity valuations, particularly of the
mid-tier players, also present a logical supposition: that now is the
time to buy rather than build.

Diminishing organic returns


More tangibly, signicant cost ination is beginning to challenge
the assumptions made, and returns expected, on major organic
growth projects. Credit Suisse estimates that capex intensity for
new production in 2014/15 is 50% higher than on projects
commissioned in 2009-2011.3

3 Metals and mining: opportunity within structural decline, Credit Suisse, 30 March 2012

The business risk report Mining and metals 20122013

35

By contrast, the theoretical cost of buying producing assets, via


M&A, has decreased. Equity values in the sector have fallen around
15% since the start of the year, though this does not factor in the
possibility of considerable control premiums in the context of steep
competition for few opportunities. Vale walked away from a
US$1.1b bid for Metorex when Chinas Jinchuan Group tabled a
competing bid that Vale had no intention of matching.4 This
decision was well received by the market as evidence of capital
discipline.

We are also seeing this at the junior end of the market, where
divestment of individual projects can prove a means of unlocking
latent value in a competitive market, and of prioritizing limited
nancial and management resources.

How are companies responding?


BHP Billiton and Rio Tinto are among those responding to the
changing market dynamics with a subtle but signicant shift of
emphasis in their capital allocation plans. BHP Billiton, for example,
announced in May 2012 that it would be sequencing the funding of
its growth projects differently in anticipation of easing of the high
commodity prices the industry has enjoyed.5 Analysts are starting
to revise their capex forecasts: rising cost ination and changing
demand patterns may mean we are reaching the peak in the
capex cycle.

Capital management today requires companies to look beyond the


pure nancials to fully assess the operational, reputational,
environmental and political risks when considering where to
allocate resources. Projects or business units must earn their right
to stay in the portfolio. The discipline and rigor with which
companies are doing this has increased signicantly since 2008.
Measured and controlled approaches to risk can drive competitive
advantage and in turn deliver leading returns. Xstrata highlights
that, as capex intensity increases, a new approach to delivering
value and returns is required, including new approaches to
procurement, social license to operate, attracting talent and
infrastructure solutions.10

Divesting to invest

Building in options

Our experience is that regular investments as opposed to


one-offs succeed better. Thats also true of divestments.
Guy Elliott, Rio Tinto, April 20126

Research shows that companies who deliver best returns are those
with a proactive and active capital reallocation strategy11 that is,
those with the exibility to re-allocate capital across business units
according to relative market or strategic opportunities. This could
be reallocation of investment from high cost/low return businesses
to those that can realize better returns now or in the future, or the
phasing and prioritization of capital expenditure to reduce capex
intensity and free up future growth options.

Capex control

An extension of the build, buy or return scenario, and an essential


element of effective capital reallocation, is the process of divesting
assets that may be underperforming, inefcient, high cost, or simply
no longer in line with companys strategy. Unlike the distressed
disposals that became a necessity following the nancial crisis,
divestments for many companies are now rmly on the strategic
capital agenda. Ernst & Youngs March 2012 Capital Condence
Barometer revealed that 35% of mining and metals participants
are looking to divest assets within the next 12 months.7
Thyssenkrupp, for example, is in the process of demerging its
stainless steel business, Inoxum, to Finnish steel producer,
Outokumpu, as part of an ongoing portfolio optimization and
strategic review. The review is aimed at reducing debt, realizing
value in the business and introducing greater exibility to pursue
growth options that better t with the companys new
strategic focus.8

4 Vale agrees to terminate the agreement to acquire assets in the African copperbelt, Vale press
release, 11 July 2011
5 BHP Billiton, 2012 Global metals, mining and steel conference audiocast, 15 May 2012
6 Breaking strategic inertia: tips from two leaders, McKinsey Quarterly, April 2012
7 Ernst & Young Capital Condence Barometer, April 2012. www.ey.com/GL/en/Services/
Transactions/Capital-Condence-Barometer
8 The Executive Board decides the further strategic development of ThyssenKrupp, Thyssenkrupp
press release, 5 May 2011

36

Managing the risks: capital discipline


If we cant meet our criteria in any one project, product or
geography, we will redirect our capital somewhere else or we simply
wont invest at all. Jac Nasser, BHP Billiton, 16 May 20129

Similarly, companies need to build options and exibility into their


approaches to capital raising. We have seen companies achieving
this on a huge scale in the bond markets, but changes to the capital
raising environment can be swift and severe, as we are seeing in the
equity markets. Companies need to be prepared for rapidly
changing scenarios with a range of options and exibility on the
balance sheet.

9 Australia, the global context, speech by Jac Nasser, BHP Billiton Chairman, to the Australian
Institute of Company Directors. 16 May 2012. Accessed via www.bhpbilliton.com
10 The changing face of supply, Xstrata presentation for Bank of America Merrill Lynch 2012 Global
Metals and Mining & Steel Conference, Miami, 15 May 2012. Accessed via www.xstrata.com
11 How to put your money where your strategy is, McKinsey Quarterly, March 2012

The business risk report Mining and metals 20122013

Lee Downham
Global Mining & Metals Transactions Leader
With economic uncertainty continuing to drive volatility and limit availability of nance, it is
imperative that capital is allocated with discipline and rigour in order to deliver long term returns
for shareholders.

Access to capital in 1H 2012


As the global economic position once again began to deteriorate in
1H 2012, capital providers became more risk averse. This restricted
the supply of new capital to the higher risk end of the sector, and
hence junior miners have found it increasingly difcult to raise
growth capital.
The availability of external sources of capital (usually via the capital
markets) is a key component of the effectiveness of a companys
capital management strategy. The industrys producers took full
advantage of market opportunities in 2011, with a focus on
renancing and maintaining credit rating strength, rather than
aggressive re-leveraging. As many governments strived to maintain
low interest rates, this afforded investment grade majors unique
opportunities for low cost borrowing via the bond and loan markets.
This they did with enthusiasm, raising US$84b of bonds and
borrowing or renancing US$187b of bank debt.
This same low interest rate environment led to an increase in
demand from investors for higher yielding investment
opportunities. This opened up the high yield market to a number of
mid-tier developers with sub-investment grade credit ratings an
important development for the industry, facilitating deal activity at
the mid-tier level.

Equity markets were less buoyant, with wide-spread volatility and


risk aversion hampering the ambitions of most companies seeking
IPO. The uncertain outlook for metals made pricing of new issues
difcult, with boards shying away from the heightened risk of
mispricing and the short-term value destruction caused by poor
after-market performance.
These trends have continued over the rst four months of 2012.
The industrys investment grade borrowers continue to exploit
demand in the bond markets, with proceeds ahead by 71% yoy.
Of major concern, however, is the continued tightening of equity,
particularly to the junior sector. The industrys juniors have
underperformed the majors, falling around 20% since the start of
the year,12 while the IPO market has continued to contract with just
US$0.5b of proceeds raised in the period. The more successful
juniors are exploring a wide range of funding options and structures
from an equally wide range of providers that includes the majors,
vertical integrators, and sovereign offtakers.
We expect volatility to continue, creating opportunities for
some and distress for others. Evaluating capital needs and
potential providers early on is imperative. It should form part of
managements broader approach to creating growth options and
to winning investor condence in its strategy and decision-making.

Steps companies can take to respond to this risk:


Companies which display best practice approaches to capital
allocation, and ultimately deliver greatest returns, are those
which demonstrate the following behaviors:

Consider all the scenarios on a consistent basis


Undertake forward-looking scenario testing

Demonstrate discipline and rigour

Consider investments in context of wider portfolio or capital


impact, not in isolation

Have a clear and agreed understanding of acceptable levels of


risk against expected return

Regularly review existing projects according to the same criteria


as new investments

Regularly and comprehensively assess risks, project economics


and assumptions

Build in options

Have clear, objective governance checks in place to manage


internal lobbying
Undertake thorough post-investment reviews performance
versus plan

Have exibility to sequence, prioritise and change the


destination of capital outlays
Pursue alternative and innovative funding options to provide
optionality

12 Performance of the Ernst & Young Mining Eye over the period 1 January 2012 to 30 May 2012

The business risk report Mining and metals 20122013

37

(new)

Sharing the benets


As the mining and metals sector continues to prosper while many
other sectors in the global economy languish, a broad group of
sector stakeholders are looking for an increasing share of the
returns of the super-cycle. As a result, we have seen this emerge
as a new risk in 2012/2013 as stakeholders ranging from the
government, to workers, the local community and suppliers, feel
they are entitled to a greater proportion of the mining and metals
company prots.
Companies are forced to balance the expectations and needs of
their many stakeholders and when they fail to meet expectations or
to fully understand these needs, the results can range from social
unrest to governments wielding their power through resource
nationalism. While companies cant control the drivers at play, they
can seek to inuence them.

Government
As mining and metals companies push into emerging markets, they
are increasingly engaging with governments that are struggling to
meet the needs of their citizens, not only from a lack of capacity
and resource perspective, but from a capability point of view. Of the
60 resource-rich developing and transition economies, it is
estimated that the 1.5 billion people living in them survive on less
than US$2 a day.1 With the high levels of protability that mining
and metals companies are experiencing with above trend
commodity prices, governments believe that mining and metals
companies should take on a role of greater support and
responsibility to the state/province and country in which it is
operating.
In the Resource Nationalism section (Risk 1), we discussed how
governments have achieved a direct nancial return in mining and
metals projects by way of increased royalties and taxes or
mandatory government stakes. However, governments now have
greater expectations of mining and metals companies to be involved
in broader community development, including:
Social infrastructure (e.g., schools, hospitals)
Logistics infrastructure (e.g., ports, rail, roads, power)
Skills development

09

There is also an increase in the reporting requirements of


investments in these countries to ensure the government optimizes
their return on resources revenue. Under Publish What You Pay
guidelines, mining and metals companies disclose what they pay
for, and governments publish what they earn. This is a way of
ensuring that governments are held responsible through advocacy
groups for responsibly managing these revenues.2

Local communities
Local communities are no longer looking for a basic economic
return for hosting a project, but are expecting a greater dividend
from mining and metals companies. Communities have two primary
needs from miners: 1) Mining activity will have minimal disruption
or impact on them; and 2) They will benet both economically and
socially. This could range from employment opportunities to
investment in education, social programs or infrastructure. And
local communities have signicant power to agitate or stop a
project from going ahead or operating efciently if their needs are
not met, forcing mining and metals companies to compromise.
Signicant conict can also arise when communities feel that the
government isnt directing enough of the prots from local projects
back into the region, with companies being caught in the crossre.
Underlying inequalities in the distribution of wealth can be ignited
by new projects. For example, in Calama in Chile, residents have
been protesting for increased resources and funding allocated to
the area by the State to address the impacts of nearby mining
projects. Residents are demanding that the Government recognize
the contribution of the region to the national budget. Mining and
metals companies can be severely impacted nancially by these
protests through delays and interruptions to projects and
production.3

Employees
With an industry-wide skills shortage as leverage, mining and
metals company employees are seeking a greater share of company
prots through higher wages and benets for their contribution to
production. Employees are often in a strong bargaining position as
the unrest is very costly to companies in lost production.

Community health improvements


Preferred hiring practices (e.g., citizens, ethnic groups)
Local procurement practices

1 Consultation of IMF Resources Work, Publish What You Pay UK, http://www.imf.org/external/np/exr/
consult/2012/nr/pdf/Comment6.pdf
2 Publish What You Pay (PWYP), Investor Watch Institute, http://www.revenuewatch.org/training/
resource_center/backgrounders/publish-what-you-pay-pwyp
3 Decentralizing Chile, bUSiness Chile Magazine, 18 April 2012, http://www.businesschile.cl/en/news/
special-report/decentralizing-chile

38

The business risk report Mining and metals 20122013

Mike Elliott
Global Mining & Metals Leader, Ernst & Young
Mahatma Gandhi once said, Earth provides enough to satisfy every mans needs, but not every mans
greed. More effort is being expended in sharing the benets rather than growing the benets.

Examples of wage strikes in 2011 are numerous and include:

Shareholders

Freeport-McMoRan Copper & Golds Grasberg mine in Indonesia


faced one of the largest-ever industrial actions in 2011. The
three-month wage strike ended after the company agreed to a
large pay hike, equivalent to a 40% increase over two years on
a compounded basis 4

The risk reward relationship is a ne balancing act for mining and


metals companies. As each stakeholder increases their return,
companies need to ensure they are not taking on too much risk
for their share of return.

According to BHP Billiton, Australia becoming one of the worlds


higher-cost countries, where mineworker unrest at BHP Billitons
Queensland coal business alone totalled 3,200 incidents of
industrial action in 2011, with less than 24-hours notice being
given for the withdrawal of half of the 1,000 industrial-action
notices5

For listed companies in particular, shareholders expect superior


nancial returns for the risk of owning equity in a mining and metals
company, especially during periods of higher commodity prices.
However, offering this return to shareholders in the form of higher
share prices and dividends is becoming increasingly challenging for
management in light of increased division of prots being taken by
all the other stakeholders. Therefore, this squeeze on returns also
has the ability to decrease the attractiveness of mining and metals
shares if the risk does not deliver higher returns.

Suppliers

Outlook

As miners have sought to increase supply, they have been


increasingly dependent on suppliers to provide goods and services
at greater quantities than before. Many mining services and
equipment companies have enjoyed higher prot margins in recent
years due to scarcity of these required products and services, which
range from freight-based services to drilling and equipment. Huge
premiums have been paid for tyres, assays, acid and port access.

Mining is an inherently risky business, but a risk most miners


accept. Miners are willing to yield some returns on the appropriate
transfer of risk. However, many of the stakeholders who want an
increased share of the mining and metals prots are not taking on
additional risk for this increased return. This means the companies
are being forced to take on the increased risk with reduced returns.
Managing this risk/reward imbalance is a key feature of modern
management of mining and metals companies.

Several mines in Chile, Peru and Zambia have experienced strikes


for higher pay

Price increases were originally driven by shortages of such


equipment, but now that supply has caught up with demand, this
is no longer the case.

Steps mining and metals companies can take to respond to this risk:
Assess stakeholder claims in the context of mine valuation
Obtain trade-offs that limit the impact on mine valuation
Use risk transfers as a value creating trade-off

As sharing the benets is short term, locking in the stakeholders


for the long term is a positive trade-off
Increase the transparency in reporting about who benets from
a mine or a facility

4 Freeport-McMoRan Copper & Gold Inc. Announces Successful Resolution of PT-FI Labor Issues
and Updates Status of PT-FI Operations, Freeport-McMoRan Copper & Gold press
release, 14 December 2012
5 Worlds biggest miner pulling in its horns, Mining Weekly, 16 May 2012 , http://www.miningweekly.
com/article/worlds-biggest-miner-pulling-in-its-horns-2012-05-16

The business risk report Mining and metals 20122013

39

(same as 2011)

10

Fraud and corruption


Fraud and corruption continues to be a signicant risk for many
companies, particularly as mining and metal companies continue
to expand into frontier countries. The effects of fraud and
corruption are far reaching and can seriously impact a companys
reputation and social license to operate and, in turn, its bottom
line. The extent of fraud and corruption and the associated
effect on both private and public citizens of countries have led
governments to implement far reaching regulatory changes.

All completed UK bribery and corruption cases


(20082011)
Actions against individuals
(number of individuals
involved)

Actions against corporates


(number of corporate
involved)

2008

2009

New regulations

2010

New laws, including the UK Bribery Act and the US Dodd-Frank Act,
are aimed at more strongly enforcing corporate responsibility. In
addition, an increasing number of countries are adopting their own
anti-bribery laws, including China, Russia and Mexico, with laws
being drafted to establish or broaden bribery offences in Brazil and
India. This, combined with increasing co-operation between global
enforcement agencies, is putting further pressure on companies to
strengthen their fraud and corruption controls as companies have
become more accountable for their actions, and management and
company directors now hold a higher level of personal risk.

2011

11

Enforcement of these regulations is becoming more active,


especially in the UK where international pressure has seen a rise
in enforcements, targeting both corporate and individuals.
In the United States, the reach of the Foreign Corrupt Practices Act
has been broadened through linkages with associated laws and their
enforcers, such as:
The Travel Act to prosecute private sector bribery
Anti-money laundering laws to prosecute foreign ofcials
Referrals of cases from the Department of Justice Antitrust
Division to the Fraud Division
Completed UK prosecutions, between 2008 and 2011, show a
trend towards targeting individuals. During 2011 six directors in the
UK received prison sentences of between 6 and 21 months showing
action against directors remains a key element of enforcement. We
see an upwards trend of successful prosecutions as regulators
become increasingly aggressive and proactive in the enforcement
of existing and new bribery and corruption laws.

Source: UK Bribery Digest, Edition 1, Ernst & Young, January 2012

What was learnt from these prosecutions?


Looking at the all cases prosecuted in 2011 (including resources
companies) against the backdrop the new UK bribery laws, we note
the following:
Criminal vs. civil sanction civil recovery orders (CROs) have
been favored by the Serious Fraud Ofce (SFO) in recent cases
(which are made under the Proceeds of Crime Act 2002 and
enable the SFO to claw back recoverable property without a
criminal prosecution)
Self-reporting the SFO promotes self-reporting as a means to
avoid lengthy and costly criminal proceedings, but there is no
guarantee or clear guidance on what benet to expect. Nor can
the SFO plea bargain in the criminal courts. There may be many
businesses which, at this stage, choose not to self-report because
there is no clear advantage in doing so
Multiple enforcers organizations may focus only on the SFO
when reviewing enforcement of bribery legislation in the UK,
however they should not overlook the many other global agencies
initiating action against UK companies

How are mining and metals companies responding?


In response to new regulation and enforcement, companies are
actively changing the way they do business. For example, several top
miners have established a specic compliance teams or mandated
their existing internal compliance functions to actively manage their
exposure to bribery and corruption risks, and are also allocating
time in their internal audit plans specically to detect these issues.
Compliance monitoring is becoming crucial with many companies
seeking assurance of their compliance, specically in emerging
markets. There is an increasing recognition that external advisors

40

The business risk report Mining and metals 20122013

Paul Fontanot
Fraud Investigation & Dispute Services, Oceania Managing Partner, Ernst & Young
Bribery and corruption remain a threat to participants in the mining and metals sector. Companies are
increasingly concerned about the potential negative impact on its reputation, and realize the importance
of having an active anti-corruption control program in place that includes continuous rather than
periodic monitoring.

can contribute to the effectiveness of a companys compliance


management system, and the recent issuance of a German
assurance standard dedicated to this issue has received much
attention.

The Ernst & Young 2012 Global Fraud Survey showed that some
companies still did not fully understand the implications of this, with
15% of CFOs still believing that third parties were liable for their own
actions, therefore opening up the company to possible prosecution.

More granular changes to pre and post acquisitions activities are


being adopted and include establishing more detailed processes for
third party vetting or investigation, the recording of gifts, and the
development of awareness programs. These are being enforced in
the high risk areas of a company, such as supply chain, and the
departments dealing with negotiations with government ofcials
and the management of third party contracts. Some of the leading
practices in these high risk areas include:

In response to the area of risk around third party actions, mining


and metals companies have taken note of this risk and are
substantially increasing due diligence initiatives around third parties
as part of their corruption gap analysis, which includes specic
anti-corruption provisions in their standard contract terms.
Contractors can use this to their competitive advantage by
demonstrating compliance as part of their proposal for a contract
or preferred business partner.

Targeted policies and procedural guidance (political and charitable


contributions, travel, facilitation payments, etc.)

Whistle-blowing

Established third party due diligence protocols, including an


assessment of a third partys ability to effectively manage the risk
of bribery and corruption, including fraud risk
The right to audit contracts, or perform regular audits of the
third party
Escalated approvals for high risk transactions or suppliers
Regular employee awareness sessions, in particular targeted at
employees that deal with third parties on site, including
awareness of global whistleblower channels
Appropriate monitoring mechanisms, for example claims and
performance reviews, and the deployment of data analytics as
a detection mechanism

Third party liability


A number of anti-bribery laws contain liability without actual
knowledge provisions. For example, companies may be liable for the
actions of sub-contractors appointed by agents, suppliers or other
business partners, if proven that the result of their improper actions
beneted the ultimate customer, even without the knowledge of the
ultimate customer.

The mining and metals industry has seen an increase in the number
of whistleblower claims as a result of the Dodd-Frank Act. Not only
has the number increased, but so too has the quality of the claims
with nancial incentives given to whistle-blowers. This has forced
companies to become active in encouraging internal whistle-blowing
by providing a credible alternative to external whistle-blowing.
According to Ernst & Youngs 2012 Global Fraud Survey, 53% of
respondents had established a whistle blowing hotline.

Outlook
As cross border business continues to grow in the mining and
metals sector, companies will become increasingly challenged,
particularly in emerging markets where they have to abide by more
stringently applied regulations. To comply with continued
aggressive global enforcement efforts to stamp out corruption,
those companies involved in the extractive industries sector need to
examine their existing anti-corruption efforts and benchmark them
against leading practice.
It is important to instil the right culture and focus on setting a
strong tone from the top around zero tolerance to corrupt activities
at all levels within the organization; and management are the
custodians of this culture.

Steps mining and metals companies can take to respond to this risk:
Know and understand the key anti-corruption and bribery laws
and their reach globally

Monitor your anti-corruption compliance program, through


programs such as Anti-Bribery and Corruption Data Analytics

Become familiar with the accepted standards and guidance for


designing and effective compliance program

Incorporate anti-corruption compliance program into M&A and


joint venture due diligence

Conduct a corruption risk assessment

Periodically reassess risk and modify the anti-corruption and


bribery program

Design and implement the anti-corruption compliance program

The business risk report Mining and metals 20122013

41

Under the radar


01 Resource nationalism
02 Skills shortage
03 Infrastructure access
04 Cost ination
05 Capital project execution
06 Social license to operate
07 Price and currency volatility
08 Capital management and access
09 Sharing the benets
10 Fraud and corruption
11 Access to water and energy
12 Working with joint venture partners
13 Competing demands for land use
14 Climate change concerns
15 New technologies
16 Increased regulation
17 Pipeline shrinkage
18 Consolidation
19 New communication vehicles for
community activism

42

The business risk report Mining and metals 20122013

These risks did not make it into the global top 10


for 2012/13, but may be a top 10 risk in some
regions, or have the potential to move up in
coming years.
The issues of access to water and energy have been merged in the current year as many companies list
the availability of low cost energy and water in their top risks and ag it as the risk which is likely to
increase in prominence.

11
Access to water
and energy
(Water up from 16 in 2011;
energy the same at 11 in 2011)

12
Working with joint
venture partners
(new)

The focus on energy supply and energy mix is based on concerns about rising energy prices, energy
security concerns and sustainability goals. Increasing afuence in the developing world is boosting
energy demands. A tightening of access to conventional supply and advances in technology have made
unconventional sources commercially viable.1 Revenue lost from power outages, fuel shortages, and
intermittent or inconsistent energy supplies are a strong economic driver to include on-site renewable
energy technologies in the energy portfolio of mining and metals operations. Renewable energy
technologies are presently attractive because of the climate change implications throughout the world.
However, the mining and metals sector usually mandates that appropriate site-specic renewable
energy technologies must be able to compete with traditional energy sources at the bottom line and be
more reliable and consistent in delivering energy. Competing demands for energy are expected to
fundamentally reshape parts of the sector, such as aluminium production in China and India, and
ferrochrome production in Southern Africa.
With a growing population, and further climate change, pressure on water supplies is set to continue,
especially in developing markets. This poses a signicant threat to the mining and metals sector, as it
potentially faces more stringent regulation, higher costs and reduced water allocation. The scarcity of
fresh water, and non-market based competition for it with other productive sectors such as agriculture
and manufacturing, has led mining and metals companies to look at alternatives. With limited water
availability, technological responses to the water scarcity issues are increasingly sophisticated, and
national and international engineering companies are working intensively to nd new solutions, such as
the use of seawater via desalination, water recirculation and innovative waste disposal solutions.2

The search for growth is leading mining and metals companies to bring in partners to source new
projects, improve utilization of expensive infrastructure, access economies-of-scale, help manage
technical or political risk and comply with local regulations. To this end, joint arrangements have always
been, and continue to be, a common structure in the sector. The majority of mining and metals entities
are party to at least one joint arrangement. With the increase in joint ventures comes an increased
exposure to risks (both operator and non-operator), particularly when the sector faces more stringent
regulations around fraud and corruption, climate change, tax, etc. Companies are therefore under
pressure to be more transparent. Also, decisions will likely be driven by the operating partner of a
specic mine with the risk being that the optimal position for the operator may not be optimal for
the non-operator (e.g., the allocation of scarce resources).
In addition, for some joint arrangements, the accounting is also about to change signicantly, and not
all arrangements commonly described as joint ventures or joint arrangements will continue to be
accounted for as in the past and careful assessment will be required.3 Partners need to be cognisant of
the difculty of this task which will be impacted by the number and complexity of the arrangements to
which an entity is a party. Robust systems and processes will need to be developed and put into place to
enable the ongoing assessment of current and new arrangements.

1 Turn risks and opportunities into results: Exploring the top 10 risks and opportunities for global organizations, Ernst & Young Oil and
Gas Sector, 2011
2 Mining in Chile: a report by Global Business Reports, Engineering & Mining Journal, March 2012
3 Rening IFRS Managing the risk of joint ventures, Ernst & Young, 2011

The business risk report Mining and metals 20122013

43

13

Competing demands
for land use
(new)

14
Climate change
concerns
(down from 13 in 2011)

Increased urbanization, food security, protection of biodiversity and environmental areas, and greater
protection of cultural links to the land are all competing in the minig and metals sector for the future
use of land. Companies need to be able to dene the value in mining and deal with potential risks such
as litigation and regulatory delays. A recent example of how a developed country government is trying
to facilitate competing land use demands is the Draft Strategic Regional Land Use Plan put forward by
the New South Wales Government in Australia.4 Through this plan, the Government aims to produce a
framework that provides the infrastructure, housing and community services needed to support
expected growth in the resources sector in their agriculturally rich region. The key policy response for
resolving land use conict is a proposed gateway process, with a panel of independent experts
assessing mining proposals at an early stage to determine whether they are suitable on the subject of
land. If a proposal does not pass this stage, it cannot proceed to development application. The
continuous development of a regulatory framework is, and will remain, a major and pervasive factor in
the relationship between mining and land use to ensure that land usage decisions are made
transparently and consistently.

Climate change remains a concern for the sector. Climate change impacts must be viewed by the
sector in two ways; rstly how mining and metals activities contribute to climate change, and secondly
how climate change will impact mining and metals activities. International treaties and accords
regarding climate change are key economic drivers moving the sector to adopt and incorporate
renewable energy technologies into the mainstream of their operations. As a price on carbon becomes
more common, a carbon footprint will become an increasing liability. A strong stance on sustainability
in the sector has come to translate directly into shareholder value, resulting in a stronger position for
publicly traded companies. Many investors have come to include a companys position on climate
change as a benchmark for investment in a company, and environmental performance is increasingly
considered by host governments and lenders. Most of the major players in the international mining and
metals sector have become sensitive to this reality and consider it a major concern within the overall
scope of operations. AngloGold Ashanti, for example, has set greenhouse gas (GHG) reduction targets
that are linked to the amount of ounces of gold it produces. Recognizing cost savings and offset
opportunities from emissions trading, the company has also instigated initiatives for Clean
Development Mechanism (CDM) projects. In order to reduce greenhouse gas generation, the
installation of low-carbon electricity generation capacity (hydropower) and energy-efcient
technologies, such as efcient compressed air systems, are under consideration in the DRC and
South Africa. If projects meet the international criteria, carbon credits will be generated and traded.5
Climate change impacts on mining and metals companies include more frequent and extreme weather
events such as ooding and droughts which have forced companies to review their risk management
processes. Additionally, companies have had to review their operations in light of a potentially changed
environment (e.g., reduced water supply or frequent ooding events) and reassess viability.

15
New technologies

Mining and metals companies are investing heavily in research programs around the world to develop
new technologies and practices to increase productivity, improve safety, discover new ore bodies,
improve recovery rates, remove waste and decrease energy use. As current ore bodies mature, fewer
tier-one deposits are found and technology has become an enabler in ensuring companies can meet
the challenges of supply. As part of their Mine of the Future program, Rio Tinto announced a
US$518m investment in driverless trains6 and trucks7 for its Australian iron-ore business, as well as
large-scale testing of technologies in underground tunnelling and recovery. How well mining and metals
companies innovate will drive long term enterprise value.

(up from 19 in 2011)

4 Draft Upper Hunter Strategic Regional Land Use Plan, State of New South Wales through the Department of Planning and
Infrastructure, March 2012
5 AngloGold Ashanti Sustainability Report 2011, 16 March 2012
6 Rio Tinto invests US$518 million in autonomous trains for Pilbara iron ore rail network in Western Australia, Rio Tinto news
release, 20 February 2012
7 Rio Tinto expands Mine of the FutureTM programme with new technologies in underground tunnelling and mineral recovery,
Rio Tinto news release, 21 February 2012

44

The business risk report Mining and metals 20122013

16
Increased regulation
(up from 17 in 2011)

17
Pipeline shrinkage
(down from 15 in 2011)

18
Consolidation
(down from 14 in 2011)

19
New communication
vehicles for community
activism

As mining and metals companies expand their global footprint, they are exposed to both greater
regulation and greater diversity in regulation. The latest Doing Business8 ndings show a high level of
coordination and commitment from some developing and emerging market economies to regulatory
reform. Economies making the greatest strides in creating a more business-friendly regulatory
environment have been revamping their regulatory and administrative systems in multiple areas to
encourage private sector activity. However, in addition to regulation on a national level, companies are
battling regulation and reporting requirements relating to climate change, fraud and corruption
reporting through different legislation, and conict free minerals independent verication, amongst
others. Penalties for non-compliance are also increasing and can result in large pecuniary losses, loss
of license to operate and even criminal sanctions against executives and directors.
Mining and metals companies are experiencing signicant fatigue around managing the myriad of often
redundant compliance and regulatory reporting activities, the cost of which is massive and burdensome.
Increasingly, companies may seek risk convergence initiatives which allow them to coordinate the
various risk and control processes. These may help to drive down costs and, perhaps most importantly,
help enable more detailed enterprise-wide risk reporting to senior management and the board.

Despite periods of weakness and volatility, metals prices, the primary driver of exploration spending,
have improved signicantly since bottoming in early 2009, and have remained well above their long
term trends in recent years. This has boosted both exploration spending, as well as capital expenditure
on nonferrous metals mining.9 The Metals Economics Group found nonferrous metals exploration
spending rose to US$18.2b in 2011, up 50.4% from 2010. This was the largest increase since 2004.10
On the supply side, the industry still faces many of the limitations that existed prior to the 2008
economic downturn that effectively set back the clock on many developments. Despite near term
volatility, most major and intermediate producers remain committed to exploration to replace mined
reserves and strengthen and grow their pipelines, particularly while metals prices stay relatively
strong. Junior miners undertaking most of the greeneld exploration are, however, struggling to get
nance as these projects are often high risk and few succeed. The long term sustainability of the sector
is dependent on this type of investment, with discovery rates falling and new resources taking seven to
ten years from discovery to production. Future demand projections exceed supply in many cases and
ore grades are in gradual but permanent decline.

During 2011, strategic M&A dominated in the mining and metals sector where the urge to
simultaneously drive down operational costs and achieve growth remained the focus of many mining
and metals executives. Sensible, lower risk transacting was top of the agenda, which gave rise to an
increase in large scale domestic consolidations, for example in the North American coal market,
offering the promise of synergies conducted in a familiar environment.11
Continued volatility in 2012 is impacting the level of the sectors M&A activity, but a strong pipeline
indicates mining and metals companies are showing an appetite to do deals. Miners are increasingly
unwilling to sit out the volatility and are prepared to act opportunistically and strategically. Robust long
term demand fundamentals and strong balance sheets will drive deal activity through 2012. Closing
deals may prove difcult due to the following challenges: reaching agreement on valuation in the
current volatile environment; resistance from shareholders; complexities of dealing with state and local
governments; and post-merger integration risks.

The advent of Cloud computing, smart mobility and social networking will continue to transform
business and society, blurring industry and geographic boundaries. Social media and blogs connect
social activists, and online articles and discussions inuence traditional coverage by newspapers and
broadcasters on issues such as the green debate, played out openly on these new media platforms.
To mitigate the risk, a number of corporations and governments are putting more resources into
direct-to-the-public and non-government organizations communications, with facilities for feedback
and debate.

(down from 18 in 2011)


8 Doing Business 2012: Doing business in a more transparent world, The World Bank and the International Finance Corporation
9 The individual exploration budgets covered by the study include spending for gold, base metals, platinum group metals, diamonds,
uranium, silver, rare earths, potash/phosphate, and many other hard-rock metals, but specically exclude exploration budgets for iron
ore, coal, aluminum, oil and gas, and many industrial minerals
10 World exploration trends 2012: A Special Report from Metals Economics Group for the PDAC International Convention,
Metals Economics Group, March 2012
11 Mergers, acquisitions and capital raising in mining and metals: 2011 trends 2012 outlook, Ernst & Young, February 2012

The business risk report Mining and metals 20122013

45

Getting prepared

46

The business risk report Mining and metals 20122013

Is your company adequately


prepared for risk?
How well are the risks
and risk appetite
dened, communicated
and understood at your
company? If youre
not sure about the
answer to that question
then chances are your
company needs to
examine its risk prole
with some urgency.

This report illustrates the top 10 risks for mining and metals companies now and in the
coming year and outlines our view of other major challenges that could pose a threat in the
near future. It is important to note that this is only a current snapshot, and that risks are
subject to change at any time. These are not predictions, but taking them into
consideration may help companies to prepare.
Approached properly, the process of risk management can be of assistance even if a
specic event does not occur. Working through scenarios and impact studies can result in
opportunities to tighten processes and controls, leading to dialogue and action plans that
deliver value.
Ernst & Youngs experience with companies around the world suggests there is a body of
risk management practice emerging, but many companies are still doing very little to
address this issue. Many global companies are identifying gaps in their risk coverage that
tend to be business and operational, rather than nancial. There are steps that company
leadership can take to address these issues:

Conduct regular risk assessments that dene key risks and weights probability
and impact on business drivers. Many companies undertake some form of risk
assessment, but our experience suggests that many of them do not do this on a frequent
or ongoing basis. Risk assessment needs to go beyond nancial and regulatory risk to
consider the strategic environment in which your organization operates and the full
extent of its operations. This includes placing effective controls on mergers and
acquisitions, IT effectiveness, business continuity planning, project development,
operations, transaction integration and expanding into new international territories.

Conduct scenario planning for the major risks that you identify, and develop a
number of operational responses. This can be a useful part of the planning cycle and can
help to encourage innovative thinking.

Evaluate your companys ability to manage risks that you identify in


particular, ensure that your risk management processes are linked to the risks that your
business actually faces. While a risk function may bring great value in focus and
expertise, companies must avoid the danger that a central function assumes all
responsibility for risk management.

Effectively monitor and control processes as they will provide you with earlier
warning and improved ability to respond.

Keep an open mind about where risks can come from. Ours is an
increasingly interdependent global economy and risks that can damage your business
can arise in any market sector.

The business risk report Mining and metals 20122013

47

Ernst & Youngs Global Mining & Metals Center

Ernst & Young

With a strong but volatile outlook for the sector, the global mining and metals industry is
focused on future growth through expanded production, without losing sight of operational
efciency and cost optimization. The sector is also faced with the increased challenges of
changing expectations in the maintenance of its social license to operate, skills shortages,
effectively executing capital projects and meeting government revenue expectations.

Assurance | Tax | Transactions | Advisory

Ernst & Youngs Global Mining & Metals Center brings together a worldwide team of
professionals to help you achieve your potential a team with deep technical experience in
providing assurance, tax, transactions and advisory services to the mining and metals
sector.
The Center is where people and ideas come together to help mining and metals companies
meet the issues of today and anticipate those of tomorrow. Ultimately it enables us to help
you meet your goals and compete more effectively. Its how Ernst & Young makes a
difference.

Area contacts
Global Mining & Metals Leader
Mike Elliott
Tel: +61 2 9248 4588
michael.elliott@au.ey.com
Oceania
Scott Grimley
Tel: +61 3 9655 2509
scott.grimley@au.ey.com
China and Mongolia
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peter.markey@cn.ey.com
Japan
Andrew Cowell
Tel: +81 3 3503 3435
cowell-ndrw@shinnihon.or.jp
Europe, Middle East, India
and Africa Leader
Mick Bardella
Tel: +44 20 795 16486
mbardella@uk.ey.com

United Kingdom & Ireland


Lee Downham
Tel: +44 20 7951 2178
ldownham@uk.ey.com

Wickus Botha
Tel: +27 11 772 3386
wickus.botha@za.ey.com

Evgeni Khrustalev
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christian.mion@fr.ey.com
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anjani.agrawal@in.ey.com

Ernst & Young refers to the global


organization of member firms of
Ernst & Young Global Limited, each of which
is a separate legal entity. Ernst & Young
Global Limited, a UK company limited by
guarantee, does not provide services to
clients. For more information about our
organization, please visit www.ey.com.

Andy Miller
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Service line contacts


Global Advisory Leader
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assurance, tax, transaction and advisory
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are united by our shared values and an
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About Ernst & Young

Tracey Waring
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2012 EYGM Limited.


All Rights Reserved.
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This publication contains information in summary form
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or the exercise of professional judgment. Neither
EYGM Limited nor any other member of the global
Ernst & Young organization can accept any responsibility
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