What does the New Year hold for miners?

This time one year ago, mining companies were battling weak commodity prices and decimated market values, with many under pressure to raise cash or shift debt. Still-high operating costs coupled with faltering metal prices wreaked havoc on margins, and the daily announcements of mine closures and project cancellations compounded the grim mood.
Since then, however, things have brightened up considerably. In many cases, balance sheets have been restructured, prices for everything are looking healthier and, overall, the industry seems to be making progress towards improving operating costs.

But it is clear that, while most of the mid-sized to large miners are back on solid ground, many juniors and early-stage exploration companies still find themselves distressed and stuck in survival mode. Analysts expect that the situation could lead to a flurry of merger and acquisition (M&A) activity over the coming months, especially as credit markets improve.

Large mining companies that have access to capital are under pressure to replenish declining production profiles, and are looking to add lower-cost projects to help improve overall margins. However, the global financial crisis has shaken the confidence of many companies, prompting more rigorous screening processes and a lot of deals being abandoned at the due diligence stage.

Companies are also demonstrating more strategic thinking on acquisitions – looking for an acquisition when the time is right, instead of resource replacement at any price. That said, corporate activity is still expected to pick up in 2010, particularly with the emergence of deal-seeking predators and scavengers from developing countries, and, most notably, China, which are on the prowl for resources.
The number one business risk for miners is cost containment. The mining and metals landscape has changed faster and more dramatically than anyone thought possible, and market unpredictability – particularly on the cost side – is quickly becoming the gest challenge mining and metals companies face. Companies need to be increasingly flexible and creative when it comes to managing capital and their cost structures in 2010.

Late in 2008 and into 2009, miners took drastic steps to lower costs and stay afloat – laying off workers, renegotiating supply contracts, improving efficiencies and, in some cases, curtailing higher cost production. Overall, equipment and skills shortages have eased in recent months and those companies that have implemented sustainable cost reduction strategies should see an easing of cost pressures during 2010.

However, significantly declining costs will only be within reach of firms operating in US dollar jurisdictions. For most other producers operating in emerging markets with stronger currencies, cost pressure will remain. Further, while input costs like steel and oil started dropping in response to sluggish global economic activity, recent sharp rallies in prices for a lot of these inputs will likely start pushing costs higher again.
On the labour side, the cost of what one might call skilled industry workers – mining engineers, geologists and so on – peaked in 2008 and is still going down in many cases. Labour costs for general workers will usually follow commodity prices.

These – most notably gold – will lead to lower grades being mined, which translates into higher production costs. This is both a function of mining taking advantage of extracting metal that has now become economic, but also, and here lies a problem, the continuous decline in global average resource quality.
The third-highest risk, behind costs and consolidation, is access to capital. With debt finance still difficult to come by for most companies, new or ‘alternative’ vehicles of finance are becoming increasingly sought after, as the sector is forced to become more innovative. With the emergence of a new set of investors, including sovereign wealth funds, private equity, Islamic funds and Middle Eastern and Asian banks, there are new sources of funding becoming available for both the majors and smaller players.

While 2009 started with what seemed at the time to be an endless list of projects being cancelled and mines being shut or curtailed, it will be interesting to see how many of these assets start seeing some action again next year. Demand for industrial commodities like copper, iron-ore and coal will depend on economic activity both in China, which has been the driver this year, and in Europe and North America. For many miners, especially ones whose traditional markets have been the US and Western Europe, Chinese demand alone is not enough to justify ramping up production.

( An expanded version of this article appeared in The Mining Weekly.)