05 Wms Green Fields Renaissance

7/31/2019 05 Wms Green Fields Renaissance

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TheCaseforaGreenfieldsRenaissance

J.M.A.Hronsky,B.J.Suchomel,andJ.F.Welborn

The collapse in commodity prices in the latter half of 2008, triggered by theGlobal Financial Crisis,

heraldedaclearendtothemostrecentBoomCycleinthehistoryoftheglobalminingindustry. Atthe

beginningofanuncertain2009,itisopportunetoreviewandreflectonthelargescalecontextinwhich

ourindustry,andinparticulartheexplorationsector,operates.

Thestrongincreaseinglobaldemandformineralcommoditiesthatwesawovertheperiod20032007

wasdrivenbyrapideconomicgrowth inEastAsiaand,toa lesserextent,SouthAsia.Thisdemandfor

growth ledtoanunprecedentedglobalfocusonthemineralresourcesector. Asaresult,manymajor

organizations,

particularly

from

East

Asia,

entered

the

global

mineral

commodities

market

for

the

first

time.An initial focusonbuyingmineralsproducedbyothers rapidlyevolved toamoveupstream to

securetheprimarysourcesofmineralproduction. Thistrend,togetherwithprevailinghighpricesfor

mineral commodities, resulted in strong price increases for the pool of known, undeveloped and

available mineral assets, most of which were discovered decades ago and remained undeveloped

becausetheywereoffundamentallypoorerqualitythanthoseassetswhichwereputintoproduction.Withthebenefitofhindsight,itisnowpossibletoseethatthepricespaidformanyoftheseassetswere

significantly greater than their underlying value. In fact,many of them are probably unlikely to be

economicallyviableunderany foreseeable setof longterm conditions. Their initialacquisitioncould

onlyhavebeenjustifiedbyaworldviewthatassumedthatastructuralshiftintheglobaleconomyhad

occurredandboomlevelcommoditypriceswouldnowbethe longtermnorm.Weareallawarethat

this assumptionwas dramatically punctured this year.Many companies appear to have based their

growthstrategiessolelyonthisassumptionandhavenowsufferedsignificantreductions inenterprise

value.

Themostsignificantlessontoemergefromtherecentboomisthatincreasesincommoditypricesalone

arenotenoughtomakepoorqualitydepositseconomicallyviable! Thisconclusionmightseemtobe

counterintuitiveatfirstglance,butitiseasilyunderstood.Inanyenvironmentofboomingdemandfor

metals,thekeycostinputstometalproduction(energy,materialsandskilled labour)alsodramatically

increaseinprice(althoughwithalageffect)andthereforemarginschangelittle.Furthermore,minesare

mostoften

very

large

projects

with

many

integrated

parts

that

must

work

together

with

relatively

low

variationinordertoproducesatisfactoryreturns.Lowqualitydepositsinherentlyrestrictthemarginfor

error (i.e. variability) and this is probably why most newlydeveloped lower quality deposits incur

significantwritedownsduringtheearlystagesofproduction.

A key question thatour industrymust address at the beginning of 2009 iswhy the current pool of

availableresourceassets isofsuch lesserqualitythantheworldclassminesthathavesustainedus in


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the past. We believe that the fundamental reason is the lack of investment by the globalmineral

industryingreenfieldsexplorationoverthelasttwentyyears.

Greenfields (also sometimes referred toas grassroots)exploration is theway thatallmajormining

districtsbeginandisthefoundationofourindustry. Greenfieldsexplorationseekstodiscovermineral

depositsin

new

areas,

away

from

the

immediate

vicinity

of

producing

mines.

In

contrast,

brownfields

exploration seeks to find new deposits close to existingmines. Greenfields is a highrisk, but high

reward,businessthatcreates longtermoptionvalue forthediscoverersofnewdeposits.Brownfields

exploration is lowerrisk,but isunlikelytodelivermorethan incrementalgrowth,andthebrownfields

explorationopportunitiesinanyonelocationwillultimatelybedepleted.

Geoscience Australia has recently compiled expenditure data for the last two decades of Australian

mineralexploration(Figure1).Thesedataclearlyillustratealongtermdeclineingreenfieldsexploration

expenditure.Duringthesameperiod,brownfieldsexpendituregraduallytrendedupwarduntil2003,the

startoftherecentminingboom,whentherewasexplosivegrowth.

0

200

400

600

800

1000

1200

1400

1983-1984

1985-1986

1987-1988

1989-1990

1991-1992

1993-1994

1995-1996

1997-1998

1999-2000

2001-2002

2003-2004

2005-2006

Exploration

spending

2006-07

$s

All Other Areas/New Deposits $ m

On Production Lease/Existing Deposits $ m

Figure1:AustralianMineralExplorationExpenditureinconstant200607Dollarsseparating

greenfieldsfrombrownfieldsexpenditure.Source:GeoscienceAustralia(basedonABSsurvey

data

deflated

by

CPI)

Howshouldweinterpretthesedata?

Greenfieldsexplorationisahighrisk,longtermactivitythatcompaniestendtoneglectduringtimesof

poormineralprices.Theperiodfromthemid1970sto2002wasoneofgenerallydecliningrealmetal

prices and relatively flat demand growth that followed a period of globally successful greenfields

mineralexplorationbetweenabout19601975.Therefore,itisnotsurprisingthattheperiod19752002


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sawageneraldeclineingreenfieldsinvestment,andthiscontributedtotightmineralsupplyatthestart

oftherecentminingboom.

Beginningin2003,adramaticchangeoccurredinthemacroeconomicenvironmentfortheglobalmining

industry.AsillustratedinFigure1,theresponseoftheminingindustryhasbeentoincreasebrownfields

explorationdramatically.

The explanation for the brownfields explosion probably relates to the recent large expansion in

production capacity of existingmines (including thedevelopment ofpreviouslyuneconomic satellite

deposits) in response to surgingdemand. The inevitable consequence is the shorteningofmine life,

unlessexplorationcankeepup,andthereflexiveresponsetothischallenge isto increasebrownfields

explorationbecauseitistheonlyexplorationthatcanhaveashorttermimpactonoresupply.

Manylargecompanieshaveassumedinrecentyearsthattheywouldnolongerneedtodogreenfields

becausethelarge(althoughveryvolatile)increaseincapitalflowstothejuniorsectoroverthelasttwo

decadeswouldseethemincreasinglydoingthiswork. Unfortunately,asillustratedbyFigure1,thishas

clearlynot

been

the

case

and

in

general,

the

majority

of

investment

by

juniors

has

been

even

more

incrementalandshortterminfocusthanforthemajors.

Greenfieldsexploration remains relativelyneglected for several reasons.Fordecisionmakers in large

companiesandfortheinvestmentmarketthatfundsjuniorexplorers,greenfieldsexplorationstruggles

to competewithbrownfields exploration. The returns arenot as immediate, and in recentdecades,

greenfields investment has probably not delivered enough quality, high option value deposits to

maintain favor in the riskreward tradeoffs of portfolio management. In addition, there remains

widespread belief that new greenfields exploration is not really required due to the considerable

numberoflowgrade,lowqualitydepositsthatexistaroundtheworldandthatwerediscoveredduring

anearlier

(1960

1975)

period

of

greenfields

success.

However,

as

discussed

above,

we

are

now

seeing

that many, if not most, of these lowquality deposits are not economically viable, even in an

environmentofhighercommodityprices,duetoextremelyhighdevelopmentandoperatingcostsand

to social concerns. In addition, the recentmassive global deleveraging process is producing amore

stringentcreditenvironment,and thismeansthatborrowingto financedevelopmentof lowerquality

depositswillbecomeevenmoredifficult.

The focus on brownfields exploration, though rational in the shortterm and for individual smaller

mining companies, will exacerbate longterm problems for the globalmineral supply. Recent large

increases in production capacity imply that, since the beginning of the recent boom, the ratio of

greenfields

expenditure

to

unit

of

metal

production

has

fallen

dramatically

and

may

now

be

at

historicallylowlevels.Itisverylikelythatstrongfundamentaldemandforresourceswillcontinueinthe

midlongterm,irrespectiveofthecurrentglobalfinancialcrisis.Itisthereforeaconcernthat,atatime

whenthelongtermchallengesofmineralsupplyremaingreat,wehavetheworstlongterminvestment

ratioingreenfieldsexplorationofrecentdecades!Attheindustryscale,brownfieldsexplorationisalowerriskinvestmentthangreenfields;however,ina

givenminingdistrict,itisinevitablyhardertosustainbrownfieldssuccessovertime.Moreimportantly,


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greenfields exploration is a long term business that requires persistence, planning and good risk

management. It cannot be switched on after high quality brownfields opportunities have been

exhausted.Therefore,itiscriticalthattheindustryputinplacegreenfieldsprogramsnowsotheyhave

thetimetodeliverresultsbeforewestarttoconfronttherealityofwidespreadbrownfieldsdepletion.

Thedata

in

Figure

1only

relate

to

Australia;

although

we

are

not

aware

of

similar

data

from

other

jurisdictions, our anecdotal experience suggests that this is a widespread phenomenon. With the

exceptionofCanada,andinparticulartheprovinceofQuebec,thereislittleevidenceofthemostrecent

miningboomresultinginamajorincreaseinlevelsofgreenfieldsexploration.

Anotherglobalfactoristhatpriortothe1990scountriesintheformercommunisteconomicsystemall

maintained very large state mineral exploration groups charged with the systematic longterm

delineation of mineral resources. These groups were not governed by market considerations and,

although arguably inefficient in many respects, were responsible for a large proportion of global

greenfields discoveries in preceding decades. These discoveries were not just made in communist

countries,butalsoinmanynonalignedstates,particularlyinAfrica,thatreceivedaidfromtheformer

SovietUnion. These groups all essentiallydisappearedwith the fallof communism, and themarket

orientedorganizations thathave replaced them in thesecountrieshavebeenmuchmore focusedon

exploitingpreviouslydiscoveredresourcesthanfindingnewgreenfieldsdeposits.

What is required toprovide thenecessary increase inglobalgreenfieldsexploration?Asanexample,

fiscal incentiveshavebeenput inplace inQuebec thatprovidepreferentialtreatmentforexploration

north of a certain latitude, thereby favoring greenfields exploration. This seems to have led to an

increase in greenfields exploration expenditure and in the success rate. Similar incentives areunder

considerationby theAustraliangovernment.Perhapswewillseetheemergenceofnewplayers from

Asiawhotakealongertermviewoftheproblemsofmineralsupplyandthereforesee ittobeintheir

longterm

interests

to

sustain

significant

levels

of

greenfields

exploration.

The

Japanese

agency

JOGMEC

alreadyhasastatedstrategywhichfavorsinvestmentingreenfieldsexplorationprojects.

It isalso critical thatgreenfields capabilitybe increased;weneeda renaissance that (like theperiod

19601975) looksforandapplies innovativescience inunexploredandhardtoexploreareas, i.e.,that

encouragestherisktakers.Sucharenaissance,however,willrequirethefollowing:

Theremustbebettereducationof seniormanagement inminingandminerals companiesaswellasgovernmentsand financial industryworkersas to thevaluepropositionofgreenfields

explorationanditschallenges.

There must be more financial incentives (i.e., incremental reduction of shortterm risk).Brownfieldsisofteneasiertosupportbecausecostscanbecapitalizedandamortized.Withthe

exceptionofQuebecandotherflowthroughregimes inCanadatherearealmostnorealshort

termfinancialincentivesforgreenfieldsexploration.

Industry capability and experience in the discipline of greenfields explorationmust improve;thereisnouseincreasingsupportforgreenfieldsifthemoneywontbespenteffectively.


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Finally,theshorttermviewthat ispervasive inpubliccompaniesandcapitalmarkets isaconsiderable

hurdle for a greenfields renaissance. The focus on immediate returns and return ranges makes it

extremelydifficulttotreatgreenfieldsinvestmentasnondiscretionaryatsomebaselevel,whichitmust

be to succeed. Much of this shortterm thinking makes the fundamental philosophical mistake of

confusingrisk(i.e.,theprobabilityofapositiveeconomicreturnfromaproject)withcertainty(i.e.,level

ofknowledge

regarding

the

probable

project

parameters).

For

example,

an

acquisition

target

with

a

relativelyhighlevelofcertaintymaybeamuchhigherriskopportunitythananexplorationprojectwith

highlyuncertainoutcomes,ifitrequiressustainedboomlevelcommoditypricestobeviable.

There is a clear case for the global mining industry to reverse the longterm trend of declining

greenfieldsexploration.Thecasebecomes increasinglyurgentasweexpandproduction fromexisting

mineswithoutacommensuratelongterminvestmentinfindingnewminingdistricts.Onecanonlyhope

that larger companies might lead the way, especially when faced with the limits of brownfields

explorationandofmergerandacquisitiondrivengrowth.

05 Wms Green Fields Renaissance

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