Costs, costs and then costs has been the mantra of the mining sector in recent months.
Your scribe attended an industry conference last week and the focus was largely on – you guessed it – all-in costs.
In part as devil’s advocate, therefore, this week Strictly Boardroom presents some countervailing views to the prevailing mining industry mantra – including a different slant on how the industry should look at its costs.
Not that costs aren’t important – they clearly are – but they are not the only issue in the mining town.
Perhaps, if collectively we were better at managing mining operations than we presently are, then costs could be viewed more as strategic opportunity rather than perceived as the most major of threats to present and future business success?
So here are two “heretical” points of view – first on mining costs and then on new mine investment – with brief explanations as to why such contrarian thinking may not be quite as crazy as it first appears.
Challenging belief #1: low-cost mines are good, high-cost mines are bad.
That must be right – yes?
Of course in the general case it is broadly right. Who would not want a low-cost mine versus a high-cost one?
But miners need to be careful as to how low-cost mines enter a corporate portfolio.
Pay too much and they are not really low-cost mines at all.
Full economic costing of acquisitions can reveal this – and the major post acquisition write-downs of the most recent financial year are a clear line of evidence that we aren’t quite there yet in optimising our decision-making to gain access to low-cost assets.
Consider this related question then. When would you purposely buy a high-cost mine?
Never ever? That may not be the correct answer.
Firstly, acquisition of a cheap high-cost asset might be perfectly rational if you anticipate the relevant commodity price to rise in future.
Secondly, you might acquire a high-cost asset if you were actually a better miner than your peers – a company capable of running the asset at a lower cost.
That very few companies buy high-cost mines for the latter reason is a reflection of the current state of our industry. No one mining company is all that much better than its peers.
Therein lies the opportunity for any company able to become “the Toyota of mining”, so to speak.
Challenging belief #2: commodity prices are falling – quick, cut back on new investment.
This mantra has also pervaded 2013 in spades. Shareholders no longer trust management to spend money wisely on new mine developments – so they want their money back please.
After all, commodity prices are falling. Actually, this thinking should be challenged too.
Many years ago your scribe did just that, with a financial model in nickel that showed companies would actually increase their chances of a strong financial return if they built new mines when prices were falling, not rising.
By the time the mine built at the bottom of the cycle hit full production, nickel prices were inevitably higher.
Conversely, those nickel mines built when prices were at their highest suffered the opposite outcome – lower prices when production hit its straps.
Not easy I know. I can almost hear the feedback: “Just you try fronting up to a bank with the message that prices are going down so please loan us the funds to build a new mine please”.
The irony is that this is actually the right thing to do – however crazy it might sound.
The difficult of raising the equity side without excessive dilution is yet another challenge.
What’s pertinent, however, is that the old financial model did not even factor in the fact it is cheaper to build a mine in the downturn – so the already positive outcome of “buying straw hats in winter” was actually underestimated.
Building a mine now is actually the right time to do it from an economically rational perspective.
It is a pity the market and its participants are not always rational.
Makes you think, doesn’t it?
Allan Trench is a professor of mineral economics at Curtin Graduate School of Business and professor (value and risk) at the Centre for Exploration Targeting, University of Western Australia, a non-executive director of several resource sector companies and the Perth representative for CRU Strategies, a division of independent metals and mining advisory CRU Group (firstname.lastname@example.org).