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Global Mining Risks Mushroom Fueling Uncertainty

Wednesday July 11, 2012 14:36

Resource Nationalism leads Top 10 List of risks for Mining & Metals

Iron Ore MiningThe risk landscape in the mining sector has become significantly more treacherous during the past year according to the Global Mining & Metals Team at Ernst & Young. It is certainly not news that mining is one of the riskiest commercial endeavors conceivable. However, the intensity of the risk environment can vary like the temperature in an oven, as highlighted in the just released E&Y report identifying the top 10 risks facing miners in 2012.

"…there has been an absolute shift that has made… [the top 10 risks] significantly 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." [Emphasis ours]
- Business Risks Facing Mining & Metals 2012-2013 - E&Y Annual Report

Resource Nationalism & The Top 10 List

Top 10 Mining Risks (2012)For the second year running, the E&Y report identified Resource Nationalism as the number one risk faced by mining concerns. This risk factor leapt to the top spot two years ago from fourth place as national governments have sought an ever increasing piece of the pie during a period of surging mining profits derived from the decade-long bull market in commodities.

"The uncertainty and destruction of value caused by sudden changes in policy by the governments of resource-rich nations cannot be understated. This risk continues to grow and we don't expect a slowing in this trend." - E&Y Report

The report highlights three key developments that characterize government advances on the industry beginning with the new imposition of or increase in revenue royalties and income taxes. A second development is the imposition of new or increased national ownership requirements. These are often free-carried interests, meaning the mining company bears 100% of the costs and the government gets its interest for free. In extreme cases we are seeing outright nationalization. These first two are certainly onerous but not necessarily new in concept.

The third development adds a new wrinkle to risk assessment. Some countries are implementing beneficiation requirements and export taxes or outright export bans on unprocessed raw materials.

Beneficiation refers to the refining of unprocessed raw materials. The purpose is to force lucrative mining sectors to develop refining and smelting operations in-country, which will lead to the higher-value export of refined commodity products. This in turn, it is hoped, will lead to increased domestic revenue from mining activities, increased tax receipts to the state, new industries and job creation, infrastructure development, the preservation of mineral resources and economic growth in general.

Perhaps surprisingly, these trends have emerged in mining powerhouses such as Australia, South Africa and Peru in addition to smaller but significant mining jurisdictions like Argentina, Mongolia and Bolivia.

BHP Billiton (BHP) Leads Capital Retreat as Global Risk Intensifies

Anyone following the mining sector over the last 15 months has witnessed profits rise dramatically while paradoxically share prices and market capitalizations have been decimated. Ironically, investors have fled the sector despite historic profitability. According to PwC's annual review of global trends in the mining industry released in May:

"…[despite] the world's 40 largest miners reaching record profits, company stocks significantly underperformed in the broader equity markets, losing value by year-end as a result of continuing fears stemming from the recent economic uncertainty…" [Emphasis ours]

"The global mining industry is facing a growing disconnect with a significant decline in market capitalization [despite] an increase in commodity prices, and a lack of shareholder confidence…" [Emphasis ours]

- Mine 2012: The Growing Disconnect (June 2012) - PwC

Due to the intensifying risk environment, including investor uncertainty and resource nationalism, the world's largest diversified miners are also sounding the retreat as previously aggressive global project development plans have been scaled back, mothballed or divested. Liberum Capital of London provides research on five of the largest global diversified miners; BHP Billiton, Rio Tinto (RIO), Anglo American (AAL), Xstrata (XTA) and Glencore (GLEN). They reported in May that,

"…the combined planned five-year $200-billion capex spend of the five main London-listed mining majors is coming under downward pressure from investors…"

BHP Billiton, the largest diversified miner on the planet, highlighted the current mood among mining companies by canceling a 5 year US$80 billion capex program that had been announced in February 2011 by CEO Marius Kloppers. In May, Chairman Jacques Nasser, reversed course indicating that the global powerhouse would not spend US$80 billion on growth projects as previously stated. He indicated that "…when the CEO talked about that $80 billion … the environment was different…"

Similar moves by the other majors will have a significant impact on the economic growth and government revenues of countries where they operate. Viewed in this context, the rise of Resource Nationalism appears short-sighted as it is having the opposite effect of what was intended.

Supply & Demand Outlook

Due to the tremendous uncertainty related to reports of economic weakness and intensified risk factors, investors have run for cover on the capital market sidelines while mining company management is developing a bunker mentality. Regarding production and capital expenditures, the E&Y report, quoted above, goes on to say that, in terms of capital project execution,

"The focus is shifting from a rapid increase in production capacity to careful evaluation of capital projects in an environment of heightened volatility."

- Claus Jensen, Oceania Advisory Partner, Ernst & Young

As is often stated, mining is a capital and expertise intensive industry requiring lengthy periods of time, measured in years, to get from exploration to production. The dramatic retreat of investor and company capital, in the face of real or perceived risk, will significantly retard discovery and production, the longer this capital starved climate lasts. Demand, however, is a fickle thing and can rise or fall much faster than supply can adjust to match it, having important implications for prices.

We are not convinced that global resource demand has or will contract nearly as dramatically as capital markets have in the mining and metals sector over the past 15 months. In fact, we feel, along with many others, that the retreat is significantly overdone relative to fundamentally sound prospects for global demand going forward.

"PwC mining industry leader for Africa Hein Boegman said…that demand remained robust, and long-term growth in emerging markets was more significant to the mining industry than short-term jitters in the developed world."

Therefore, we believe the stage is being set for a revived rise in commodity prices as supply is being constrained by elevated risk while global resource demand remains stealthily robust.

By Carlos Andres

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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