Report: "Business risks facing mining and metals 2012–2013"

Business risks facing mining and metals

2012–2013

Organizations that succeed do so because they are best able to optimize the risk and reward equation for both strategic and operational issues.

Cont

ents

The Ernst & Young business risk radar for mining and metals 3

Executive summary 4

The top 10 business risks 101. Resource nationalism 11

2. Skills shortage 14

3. Infrastructure access 17

4. Cost infl ation 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 benefi ts 38

10. Fraud and corruption 40

Under the radar 42

Getting prepared 46

3The business risk report Mining and metals 2012–2013

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 Ernst & Young business risk radar for mining and metals

Up from 2011 Same as 2011 New entryDown from 2011

The business risk report Mining and metals 2012–20134

Executive summary


On the surface, the top ten risks don’t look all that different from last year, but below the surface there has been an absolute shift that has made them signifi cantly 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 signifi cant 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 benefi ciation, 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There is no doubt projects around the world have been deferred and delayed, and in some cases investment withdrawn altogether, because of the degraded risk/reward equation.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 signifi cance, we don’t 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.

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 ElliottGlobal Mining and Metals Leader, Ernst & Young


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 infl ation up from number eight to four on our risk rankings.

Sharing the benefi ts 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 profi ts, 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 infl ation, 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.

So although we haven’t 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 fi ve have fallen out of the top 10 table altogether.

In a rising market, the returns have justifi ed 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.

Top ten risks over fi ve years 2008 2012

01 Skills shortage02 Industry consolidation03 Infrastructure access04 Maintaining a social license to operate05 Climate change concerns06 Rising costs (cost infl ation)07 Pipeline shrinkage08 Resource nationalism09 Access to secure energy10 Increased regulation

01 Resource nationalism02 Skills shortage03 Infrastructure access04 Cost infl ation05 Capital project execution06 Maintaining a social license to operate07 Price and currency volatility 08 Capital management and access

new Sharing the benefi ts 10 Fraud and corruption

Remained in the top 10 over 5 years


The top 10 business risks formining and metals

0102

03

Resource nationalismResource 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 benefi ciation, export levies and limits on foreign ownership.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.

Skills shortageThe 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 confi dence 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.Signifi cant 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-fi nancial benefi ts

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 accessThe long running minerals super-cycle has made lower quality or remote deposits viable, with the lack of suffi cient 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 fi 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 fi nancial strength to solely develop these projects. The key infl uences on infrastructure fi nancing include:• The changing role of government to planning, approving and

incentivizing fi 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

To fulfi l 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.


0405

0607

Capital project executionThere is a massive pipeline of projects in 2012–2015. At the same time, there has been high delivery cost infl ation 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 justifi cation and rigor —

there is a renewed focus on the integrity of data around

estimated project costs and benefi ts to aid/improve management’s level of decision-making confi dence

• 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 fl 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 operateThe consistent ranking of maintaining a social license to operate within the top six risks over the last fi 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 fi nancial returns to benefi ts 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 fi 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 volatilityEquity 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 fl 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 fl ow models that improve risk assessment and fi 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.

Cost infl ationCost infl ation 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 infl ation 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.


Sharing the benefi tsAs the mining sector continues to fl ourish while other sectors fl ounder, a wider range of stakeholders are looking for a greater share in the perceived profi ts. 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.• 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 benefi t 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 benefi ts and can incite industrial unrest if they are not achieved

• 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 profi ts already shared amongst the other stakeholders

Fraud and corruptionFraud and corruption remains on this year’s risk radar due to the increased political risk we’ve 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 company’s 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. 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 specifi c anti-corruption provisions in their standard contract terms

• Whistle-blowing — companies have been forced to become active in encouraging internal whistle-blowing by providing a credible alternative to external whistle-blowing

0809

10

Capital management and accessBoards 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 infl ation 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.

The risk of sub-optimal allocation of capital can have a signifi cant and long-lasting impact. Companies are responding to this risk by building options and fl exibility into their capital agendas through: • Opportunistic refi nancing• Strategic divestments and reallocation of capital• Innovative approaches to capex disciplineThe challenge for mining and metals companies is to remain true to their long-term strategy, while building in fl exibility to respond to short/medium term opportunities and risks.


The top 10 businessrisks


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 taxesAmendments to mining and tax laws can result in changes to capital allocation based on a weaker risk/reward profi le.

The announcement in 2010 of a proposed new ‘super profi ts’ mining tax in Australia had a signifi cant ripple effect around the world. Many mining and metals jurisdictions announced increases in taxes and royalties during the course of 2011–12 and many looked at Australia’s 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 profi ts’ 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.

During 2011 and for the fi 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.

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

2. Mandated benefi ciation/export leviesMany governments are now seeking to have minerals benefi ciated in-country prior to export. South Africa has announced a benefi ciation 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 profi le due to mandated benefi ciation include:

• The high cost of establishing refi neries or smelters if not already established in the country

• The need for both low cost power and infrastructure for benefi ciation plants — both of which are often in short supply in these countries

• The need for skilled labor for value-added processing • Loss of fl 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 benefi ciation 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

In order to better ensure in-country benefi ciation, governments are imposing new steep export levies on unrefi ned 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 fi nished goods from an exporter of raw materials.

2 Anonymous company quote to Ernst & Young contact

01Resource nationalism

(same as 2011)


3. Retaining state or national ownership of resourcesGovernments 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 signifi cant 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 decisionThe 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 Confi dence 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, greenfi eld sites or in expanding existing operations. In either case, they will

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 company’s 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 investmentGovernments 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 signifi cant ‘multiplier effect’ associated with the development of new mines.


Product of consultationIn many resource-rich countries, the capital investment can be signifi cant. For example, in Peru, the Government is forecasting investment into its mining sector of US$53b over the next fi 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 fi 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:

• A more effi cient (profi t based) taxation system• Removal of ineffi cient taxes• Speeding up the development approval process• Improving fl exibility of labor

3 Peru dangles its investment credentials, MiningnewsPremium, 23 May 20124 Peruvian miners brace for tax news, Financial Times, 25 August 2011

Mining and metals companies are looking at the government consultation process as a means of preserving value as opposed to just defending fi 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.

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 the host government’s long-term economic and political incentives and thereby become an invaluable part of the infrastructure in the host country

• Focus on generating direct and sustainable benefi ts for the host community through pro-active and well organized social and community development programs

• Align with multi-lateral agencies, such as the World Bank, to achieve a ‘prominent victim’ status in the face of mounting resource nationalism

• Partner with state owned enterprises that have strong Government-to-Government relationships

• Encourage direct government participation

“With the massive increase in resource nationalism, comes an increased need for tax directors to be more involved in strategic risk decisions.”

Andy MillerGlobal Mining & Metals Tax Leader, Ernst & Young


02Skills shortage

(same as 2011)

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 magnifi es and escalates the problem. However, the outlook on investment is cautious, with companies prioritizing and sequencing investment in projects, thus impacting skills demand-and-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 diffi cult 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 signifi cant:

1. Impact to production output — there is a risk that insuffi cient skills may limit current and/or planned output. According to BHP Billiton, Australia’s resources industry needs an extra 170,000 workers in the next fi ve years.2 In Canada, the Mining Industry Human Resources Council’s 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 60,000–90,000 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 diffi cult, 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 2009–2011.4 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 Group2 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.pdf4 Canadian Mining Industry Employment and Hiring Forecasts, 20115 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://fi nance.yahoo.com/news/Newmont-Mining-posts-4Q-loss-apf-4285689275.html, accessed 17 May 2012

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 insuffi cient numbers and/or skills available in the local market. Therefore, being able to attract and mobilize key talent globally in a cost effective and effi cient 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 & Young’s 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 infl uence their employment decision.

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


“There is no easy fi x to the skills shortage issue, but being creative and fl exible in your approach can open up new pools of talent.”

Louise RollandExecutive Director, Advisory, Ernst & Young

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

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

c. Individually tailored

Set remuneration at competitivebut not inflationary levels

Understand what is important Understand what is differentacross workforce segments

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 benefi ts. In order to retain employees, companies need to engage with them at multiple levels7 and clearly communicate the full range of benefi ts 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-fi nancial benefi ts

Companies are also employing a range of non-fi nancial benefi ts and arrangements to assist with workforce recruitment, engagement and retention. One of these is fl 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

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

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 fl 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 benefi ts 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 profi ling the market will better enable Human Resource Directors to respond to the threat that labor shortages pose to their company’s 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

8 8/6;7/7: Example of rotating roster where working 8 days on/6 days off and 7 nightson/7 nights off9 Career and life survey, Ernst & Young


Steps companies can take 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• Create employment packages focused on career development

opportunities

• Implement early labor scheduling and sourcing within mine planning

• Develop sustainable skills development programs to fi ll these gaps

• Develop strategic alliances with institutions and communities• Target initiatives to optimize productivity• Substitute capital for labor through innovation


Five things that leading companies do well when attracting and retaining staff

1. Get the employment offer right and effectively communicate and reinforce it

2. Develop effective career pathways and well-aligned employee development programs

3. Build internal capability to effectively manage people

4. Understand employee needs and the markets in which they reside for effective workforce planning

5. Execute well across attraction and recruitment, and development and progression

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

Women and indigenous workers are two signifi cant 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 specifi c 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 benefi ts 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 country’s 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,

10 Attracting workers to the mines and retaining them, Ernst & Young, 200811 Attracting workers to the mines and retaining them, Ernst & Young, 200812 Canadian Mining Industry Employment and Hiring Forecasts 2010, Mining Industry Human Resource Council

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 Australia’s policy to increase female participation in mining includes tax deductibility of work-related child care expenses, fringe benefi ts 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, fi 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 company’s 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

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.


03Infrastructure access

(same as 2011)

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 fi 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 suffi cient 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 smaller mining and metals oganizations struggle to fund large sole use infrastructure developments

1 The global mining machinery handbook, 14 March 2012, Morgan Stanley2 http://www.opandr.com/, accessed on 20 June 20123 Chinalco sets up consortium to develop Simandou iron ore project,Xinhuanet.com, 29 November 2011

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 fi 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 fi 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 profi le gives an organization a signifi cant 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 fi nalization of project delivery. Our view is that a signifi cant portion of the synergistic value that would be generated in a more cooperative approach is being lost.

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


We expect the key infl uences on the fi 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 effi cient 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 fi rst of these issues

• Provision of incentives for the private sector to fi nance and provide necessary infrastructure either through tax incentives, orderly risk transfer, or project approvals

2. Increasing infl uence of foreign customers We are observing a continued infl uence 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 fi nancial pressure to agree to accept those terms and conditions.

3. New sources of infrastructure funding from institutional investorsPension, 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 greenfi eld or brownfi eld 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 fi nancial investors do not benefi t 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 volatilityThe global fi nancial crisis of 2008 resulted in increased debt pricing, tightening of lending covenants, reduced lending tenors and a signifi cant contraction amount of bank debt available to fi nance infrastructure projects. There has been a consequent adjustment in the banks participating in the infrastructure project fi 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 fi nancial markets and also the upcoming introduction of Basel III means the current challenges for non-recourse project fi 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 profi les. 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, justifi cation and scope rationalization prior to receiving approval. In addition, we are seeing signifi cant changes in the relative cost of developing projects — reduced productivity, changing sovereign risk profi les 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


“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. ”

Neal JohnstonPartner, Infrastructure Advisory, Ernst & Young Oceania


• Consider the extent to which infrastructure defi cits may impact on enterprise value

• Understand the return on all capital expenditure, including infrastructure, and consider appropriate fi nancing

• Look for other stakeholders to co-develop a solution with shared benefi ts

• Investigate partnerships with other potential stakeholders in expanded infrastructure to innovate fi nancial arrangements including off-take

• Improve mine planning to assist in assurance over optimal levels of take-or-pay commitments

OutlookInfrastructure 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 fi 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 profi le is effi ciently 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.


(Up from 8 in 2011)

04Cost infl ation*

Over the past decade as the sector and its suppliers have struggled to increase supply, cost infl ation has re-emerged as a major risk for mining and metals companies globally. It is estimated that the sector experienced cost infl ation of between 10% and 15% in 2011, with overall cost infl ation averaging roughly 5–7% in the last 10 years (this equates to a doubling of costs every 10–14 years).1 Cost infl ation 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.

Subdued demand and low commodity prices, while costs continue to riseAccording 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 profi ts. Take for example aluminium and nickel producers — these commodities have witnessed the most signifi cant 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 profi t 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 Billiton’s 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 refl ection of a 35% drop in nickel prices through 2011

• In 1Q12, Vale’s 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 refl ects the infl ationary environment1 Cost infl ation is major theme for metals production: Deutche Bank, Commodity Online, 16 April 20122 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 20124 1st Quarter Earnings Conference, Alcoa Quarterly Earnings Presentations, 10 April 20125 BHP Billiton Results for the Half Year Ended 31 December, BHP Billiton press release, 8 February 2012 6 Performance of Vale in 1Q12, Vale fi nancial performance, 25 April 2012

Companies revisit robust capital expenditure plans 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 profi ts. During this period, mining and metals organizations implemented signifi cant 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.

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 Kibali’s mine design and mine schedule has been optimized since the original 2010 feasibility study, this 55% increase in capital expenditure highlights rampant capital cost infl ation across the mining and metals sector.7

Capital cost infl ation 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 infl ation and increasing complexity drive operating costs Operating costs continue to increase on the back of high crude oil prices and wage infl ation. 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 infl ation is also rife across the sector, as employees seek to share the profi ts. 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 profi ts 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


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 profi ts 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 fi 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 fl y-in fl 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 specifi c to social infrastructure are increasing

8 Canada’s 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 signifi cant number of upcoming and operating gold projects in Canada’s 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 greenfi eld projects in favor of brownfi eld expansions at exiting sites where manpower, resources and infrastructure are already in place.

The currency impactIndustry-wide cost infl ation 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 infl ation, 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 201210 Western Areas buys Kagara nickel mine, The Australian, 2 March 2012; BHP to make fi rst job cuts since GFC as nickel dives, The Australian, 2 February 2012

“Cost infl ation is a risk that keeps growing, and continues to threaten profi t margins and the viability of projects.”

Paul MitchellGlobal Mining & Metals Advisory Leader, Ernst & Young


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, Vale’s procurement team holds collaborative workshops not only with other functions within the company, but also with suppliers. Vale’s “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, profi tability and cost-saving targets that mutually benefi t the miner and supplier/contractor.

Companies are increasingly turning to technological solutions to mitigate wage infl ation. The high cost of supporting a fl y-in fl y-out workforce is pushing companies to invest in automation. Rio Tinto is

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

committed to this solution with plans to spend US$483m to make its trains driverless, a decision that follows last year’s move to put 150 automated dump trucks into its Pilbara mines in Australia. The company’s 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 miner’s cost base in the Pilbara will reduce by roughly US$55m to US$77m per annum (60–90 cents per tonne of iron ore).13

12 Rio high in an empty driver seat, The Age, 6 April 201213 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


• Focus on sustainable cost reduction programs• Divestment in non-core assets• Review of capital tied up in high levels of pre-stripping, advance

development and stockpiles• Consideration of the use of contract mining vs. sale or leaseback

• Review of supplier contracts• Outsourcing• Creation of strategic joint ventures to optimize economies

of scale



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 2012–2015 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 infl ation:

• 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 effi cient 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&MJ’s Annual Survey of Global Mining Investment, 20 Jan 2012, www.e-mj.com

05Capital project execution

Commodity price trendIn 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-fl 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

• Vale’s 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 20123 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 20124 Rio Tinto reaffi rms confi dence in demand outlook , http://www.marketwatch.com, 9 May 20115 Vale announces investment budget for 2012, Vale press release, www.vale.com

(same as 2011)


The metals and mining community adaptsLeading mining and metals companies are adapting to emerging capital project risks by raising the bar on business case justifi cation, prioritizing investment pipelines and enhancing the level of project control expected of delivery teams.

• Raising the bar on business case justifi cation and rigor Business cases are made or broken on the back of estimated

costs and benefi ts 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 management’s level of decision-making confi dence.

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 project’s unique risk profi le are ensuring business cases accurately defi ne 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 identifi ed benefi ts. Companies that establish clear and single-point business case ownership can align delivery performance with an individual’s key performance indicators (KPIs) and a business unit’s 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 fl ow exposure and delivery complexity.

The assessment of strategic alignment requires mining and metals companies to determine how mega-project investments align to the company’s 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 diversifi cation of risk, price and currency

exposure?• Are aligned to commodities that the company seeks to grow,

stabilize or exit?• Are aligned to the company’s view of core business whereby

the owner’s 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 fl 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 effi ciency and effectiveness; however, this will be balanced against the predictability of proven solutions. Similarly, brownfi eld expansion projects (where there is proven cash fl ow from an existing asset and existing operational infrastructure), may be advanced in favor of greenfi eld development options.


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

Claus JensenAdvisory Partner, Ernst & Young Oceania

• 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 infl ation 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 specifi c 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 identifi es 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 confi guration (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 benefi t realization plans. Projects that demonstrate signifi cant 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.


• 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 value of reputationIt 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 fi 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.

Increased expectationsMining and metals companies are fi 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.

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 signifi cant 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.

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

06Social license to operate

(down from 4 in 2011)

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 fi xed 4% rate of operating profi ts. 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 benefi ts from mining and metals companies operating in their regions other than pure economic benefi ts 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 challengesAcquisitive 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 signifi cant challenges, potentially leading to commercial and fi nancial issues. There are numerous examples of this:

• 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

• 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 signifi cant community resentment towards the operation

• 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

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


The acquiring company needs to move quickly to set a clear tone and expectation of how business will be conducted moving forwards and signifi cant 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 doneMining 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 people’s emotions, concerns and fears”.2

2 License to chill, AFR Boss, April 2012

“Social license to operate has been ranked as a top six risk over the last fi ve years as it represents a consistent long term challenge.”

Helen AdairExecutive Director, Climate Change and Sustainability Services

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

3 ICMM hosts CEO Panel at PDAC International Convention, YouTube video, 17 April 2012,http://www.youtube.com/watch?v=ulDfE3GYm8w. Accessed 13 June 20124 ICMM hosts CEO Panel at PDAC International Convention, YouTube video, 17 April 2012,http://www.youtube.com/watch?v=ulDfE3GYm8w. Accessed 13 June 2012

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

• Embed these mitigation strategies in all critical business processes to ensure that an integrated approach is adopted

• Encourage and engaging in community/employee debate over sustainability priorities

• 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

• Link sustainability outcomes to attraction and retention of the workforce

• Improve speed to act on potential license issues• Encourage trusting and supportive relationships with all

stakeholders to reduce security risks in troubled locations• Integrate sustainability objectives into all long-term planning

The business risk report Mining and metals 2012–201328 The business risk report Mining and metals 2012–201328

Prospects and perils:facing up to political risks in mining and metalsBy Jean Devlin and Gemma O’Loghlen at Control Risks

The mining and metals sector bears the brunt of the political risks that come with operating in complex environments. With limited fl 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 confl ict — have occurred in several mineral-rich countries. The coming 12 months present a worrying landscape: complex local politics, regional power struggles and confl icts 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.

What’s mined is mineIn 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 benefi ciation 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 signifi cant 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 fi rm but sensible communicators. The most diffi cult challenges arise when policymakers act unpredictably, such as in Zimbabwe or Venezuela, taking decisions that yield few tangible benefi ts 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 fi nances? Could high

commodity prices prove irresistible to a cash-strapped government?

The debate currently raging over the ANC’s 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

29The business risk report Mining and metals 2012–2013 29The business risk report Mining and metals 2012–2013

l

Polling timeElections 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 country’s recently introduced new foreign investment law refl ects this populist element in policymaking.

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

Venezuela

Sierra LeoneGhanaGuinea Congo

Kenya

Philippines

Malaysia

East TimorPapua NewGuinea

Zimbabwe

Togo

MadagascarZambia

Angola

Burkina FasoMauritania

Mali

Ukraine

Romania

Ecuador

Mexico

United States

Mongolia

The business risk report Mining and metals 2012–201330 The business risk report Mining and metals 2012–201330

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.

Peru’s 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 Humala’s greatest challenge. The experience of investors in Peru and elsewhere underlines how foreign multinationals can be caught in the crossfi re 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 Côte d’Ivoire 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. Mali’s military coup in May 2012 was followed by political turmoil in the capital and left a power vacuum in the northern hinterland, now fi 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 fi 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 signifi cant diffi culties 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.

Tightening regulationsAside 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 fi nance standards (such as the Equator Principles) to international restrictions on trade in confl ict 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 infl uence 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 Côte d’Ivoire’s 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 confl ict in 2010–11, and President Alassane Ouattara’s desire to place foreign investment at the heart of the country’s post-confl ict recovery, has opened up new opportunities for mining

31The business risk report Mining and metals 2012–2013 31The business risk report Mining and metals 2012–2013

and metals companies for the fi 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 fi rmly in the charge of the president. The Government’s most technically competent fi gures are among Ouattara’s immediate advisers. The code is likely to be re-drafted and passed by September 2012.

Chile is a country that has managed to build up a strong mining and metals sector in the past two decades and attracted signifi cant outside investment even though the government retains a major stake in the sector

through Codelco, the state owned copper company. The country’s track record has demonstrated good protections for foreign investors in a region little known for such behavior. Meanwhile, Botswana’s effective management of its diamond wealth since the fi 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.

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.

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 specifi c issues, identify new opportunities and monitor global developments that have an impact on our clients and their commercial activities.

Editorial


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 infl uence 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


Confi dence Barometer, the mining companies interviewed indicated a dramatic drop in their confi dence in the short term market stability,6 which is perhaps mirrored in investor confi dence.

Gold price vs. HUI and PHLX index

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

HUI PHLX Gold

1/3/

2011

2/3/

2011

3/3/

2011

4/3/

2011

5/3/

2011

6/3/

2011

7/3/

2011

8/3/

2011

9/3/

2011

10/3

/201

1

11/3

/201

1

12/3

/201

1

1/3/

2012

2/3/

2012

3/3/

2012

4/3/

2012

5/3/

2012

Source: Thomson Datastream, Ernst & Young analysis

Foreign exchange volatility is experienced when an organization’s operating costs are not in its functional currency. For organizations with a substantial portion of their revenue and debt denominated in US dollars, fl 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 fl 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 Confi dence Barometer mining and metals data, Ernst & Young, April 20127 Vale S.A. Form 20-F, United States Securities and Exchange Commission, 17 April 2012

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 fl 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 profi t-taking, rebalancing of portfolios and margin calls.1

Stock market volatility tested the confi dence 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

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 confi dence 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 signifi cant margins.3

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 20122 Mergers, acquisitions and capital raising in mining and metals: 2011 trends 2012 outlook,Ernst & Young, February 20123 EYeSight on Consolidation: Backpedalling on the cycle, Ernst & Young, November 20074 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, Compañia de Minas Buenaventura, Anglogold Ashanti. Source: https://indexes.nasdaqomx.com/pdf/pdfreport.ashx?IndexSymbol=XAU5 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

07Price and currency 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 diversifi ed 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 fi 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 benefi ts 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 fi nancing. AuRico Gold’s divestments announced in 1Q12 refl ects this trend.11 AuRico Gold has two divestments. Both have a portion of the proceeds contingent on future cash fl ows. So in essence, the buyer has hedged its metal price risk by agreeing to pay in future only if cash fl ows meet certain thresholds (and cash fl 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 positions9 Gold Demand Trends: full year 2011, World Gold Council, February 201210 GFMS predicts gold prices will exceed US$2,000/oz by 2013, Mining Journal, 13 April 201211 AuRico Gold updates guidance: update follows recently announced divestitures of non-core assets, AuRico Gold press release, 15 April 2012

“Current global issues will fuel uncertainty and therefore volatility. Successful miners will be those that recognize and exploit value from volatility.”

Jay PatelTransactions Partner, Canadian Mining and Metals, Ernst & Young

impact of higher oil prices through the use of fi 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 Energy’s contribution, along with the fi 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 volatilityThe greatest asset that any mining and metals company can have during periods of great volatility is fl exibility in their operations. By fl exibility, we mean the ability to quickly, and at relatively low cost, vary the level of production. This fl exibility can be refl ected in fl exible staffi ng, fl exible maintenance scheduling and fl exible supply chains, for example. The existence and value of this optionality is recognized by mining and metals companies, but rarely quantifi ed.

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 fl ow models that improve economic analysis, risk assessment, management and fi 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


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 project’s risk characteristics change erratically over its life.

While the advances in fi 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 fi nancial reporting.

These enhanced cash fl ow modelling techniques are not the ultimate solution, but they can improve investment, fi nancing, and risk management decisions and so should be considered part of the corporate fi 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 fi 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 fi nancial results, their ability to repay debt and meet other fi 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

discontinuing certain exploration and development programs. This could lead to an inability to decrease costs in an amount suffi cient to offset reductions in revenues, and they may incur losses. Enhanced scenario planning skills will become increasingly critical over time.

Need for increased corporate governanceWith 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.

OutlookGlobal 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 infl uenced by ever-changing 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 fl 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.

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


• Identify sources of volatility that can be effectively managed — input prices, currencies and metal prices

• Pursue hedging strategies to reduce currency and inputs volatility to maintain predictable cash fl ow

• Increase fl exibility in operations and measure the benefi ts• 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

• Put in place and maintain adequate liquidity arrangements for downside protection

• Reassess hedging as a strategy to ensure fi nancial performance no matter the direction of metal prices

• Maintain a focus on costs and containing costs• Exercise prudence in capital allocation and performing stress

testing with extreme price assumptions• Diversify metal portfolio and jurisdictions to mitigate the impact

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



08Capital 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 infl ation 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 industry’s 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 signifi cant 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 fl exibility to respond to short/medium term opportunities and risks.

Capital allocationEffective capital management involves the allocation of capital resources in a way that best exploits a company’s core competencies and the market opportunities. The macro-economic backdrop and outlook (such as expected commodity demand and availability of capital) infl uence these choices.

Rising metals prices, encouraged by China’s 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 2009–2010 recovery in prices was met with a more cautious approach to growth. Large-scale M&A, perceived to be high risk and diffi cult to execute, was largely replaced by an overwhelming focus on capital expenditure (“build”) that would see an estimated US$200b invested by just fi ve of the industry’s largest companies into organic growth programs over the next fi ve years.2

* Renamed from ‘Capital allocation’ in 2011 to better refl ect 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; Rio’s capital costs global problem, Sydney Morning Herald, 3 May 20122 Miners: they think it’s all over?, Liberum Capital, 14 May 2012

By the end of 2011, companies were reporting record earnings. Cash fl 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, refi nancing 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 gapWith the producers ostensibly in a position of fi nancial strength, there is a growing “valuation gap” that appears to indicate the market is not pricing in the scale of the industry’s growth options. Forward PE ratios for the top fi ve diversifi eds, 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 confi dence 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 fl 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 returnsMore tangibly, signifi cant cost infl ation 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


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 China’s 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.

How are companies responding?Capex control

BHP Billiton and Rio Tinto are among those responding to the changing market dynamics with a subtle but signifi cant 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 infl ation and changing demand patterns may mean we are reaching the peak in the capex cycle.

Divesting to invest

“Our experience is that regular investments — as opposed to one-offs — succeed better. That’s also true of divestments.” — Guy Elliott, Rio Tinto, April 20126

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, ineffi cient, high cost, or simply no longer in line with company’s strategy. Unlike the distressed disposals that became a necessity following the fi nancial crisis, divestments for many companies are now fi rmly on the strategic capital agenda. Ernst & Young’s March 2012 Capital Confi dence 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 fl exibility to pursue growth options that better fi t with the company’s new strategic focus.8

4 Vale agrees to terminate the agreement to acquire assets in the African copperbelt, Vale press release, 11 July 20115 BHP Billiton, 2012 Global metals, mining and steel conference audiocast, 15 May 20126 Breaking strategic inertia: tips from two leaders, McKinsey Quarterly, April 20127 Ernst & Young Capital Confi dence Barometer, April 2012. www.ey.com/GL/en/Services/Transactions/Capital-Confi dence-Barometer8 The Executive Board decides the further strategic development of ThyssenKrupp, Thyssenkrupp press release, 5 May 2011

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 fi nancial and management resources.

Managing the risks: capital discipline

“If we can’t meet our criteria in any one project, product or geography, we will redirect our capital somewhere else or we simply won’t invest at all.” — Jac Nasser, BHP Billiton, 16 May 20129

Capital management today requires companies to look beyond the pure fi 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 signifi cantly 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

Building in optionsResearch shows that companies who deliver best returns are those with a proactive and active capital reallocation strategy11 — that is, those with the fl 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.

Similarly, companies need to build options and fl 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 fl 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.com10 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.com11 How to put your money where your strategy is, McKinsey Quarterly, March 2012


“With economic uncertainty continuing to drive volatility and limit availability of fi nance, it is imperative that capital is allocated with discipline and rigour in order to deliver long term returns for shareholders.”

Lee DownhamGlobal Mining & Metals Transactions Leader

37

Access to capital in 1H 2012As 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 diffi cult 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 company’s capital management strategy. The industry’s producers took full advantage of market opportunities in 2011, with a focus on refi nancing 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 refi nancing 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 diffi cult, 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 fi rst four months of 2012. The industry’s 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 industry’s 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 management’s broader approach to creating growth options and to winning investor confi dence in its strategy and decision-making.

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


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

Demonstrate discipline and rigour

• Have a clear and agreed understanding of acceptable levels of risk against expected return

• Regularly and comprehensively assess risks, project economics and assumptions

• Have clear, objective governance — checks in place to manage internal lobbying

• Undertake thorough post-investment reviews — performance versus plan

Consider all the scenarios on a consistent basis

• Undertake forward-looking scenario testing• Consider investments in context of wider portfolio or capital

impact, not in isolation• Regularly review existing projects according to the same criteria

as new investments

Build in options

• Have fl exibility to sequence, prioritise and change the destination of capital outlays

• Pursue alternative and innovative funding options to provide optionality


09Sharing the benefi ts

(new)

�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 profi ts.

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 can’t control the drivers at play, they can seek to infl uence them.

GovernmentAs 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 profi tability 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 fi 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• 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

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 communitiesLocal 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 benefi t both economically and socially. This could range from employment opportunities to investment in education, social programs or infrastructure. And local communities have signifi cant power to agitate or stop a project from going ahead or operating effi ciently if their needs are not met, forcing mining and metals companies to compromise.

Signifi cant confl ict can also arise when communities feel that the government isn’t directing enough of the profi ts from local projects back into the region, with companies being caught in the crossfi re. 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 fi nancially by these protests through delays and interruptions to projects and production.3

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

2 Publish What You Pay (PWYP), Investor Watch Institute, http://www.revenuewatch.org/training/resource_center/backgrounders/publish-what-you-pay-pwyp3 Decentralizing Chile, bUSiness Chile Magazine, 18 April 2012, http://www.businesschile.cl/en/news/special-report/decentralizing-chile


“Mahatma Gandhi once said, “Earth provides enough to satisfy every man’s needs, but not every man’s greed.” More effort is being expended in sharing the benefi ts rather than growing the benefi ts.”

Mike ElliottGlobal Mining & Metals Leader, Ernst & Young

39

Examples of wage strikes in 2011 are numerous and include:

• Freeport-McMoRan Copper & Gold’s 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

• Several mines in Chile, Peru and Zambia have experienced strikes for higher pay

• According to BHP Billiton, “Australia becoming one of the world’s higher-cost countries, where mineworker unrest at BHP Billiton’s 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 notices”5

SuppliersAs 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 profi t 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.

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.

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 20125 World’s 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

ShareholdersThe risk reward relationship is a fi 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.

For listed companies in particular, shareholders expect superior fi 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 profi ts 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.

OutlookMining 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 profi ts 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.


• 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 benefi ts is short term, locking in the stakeholders for the long term is a positive trade-off

• Increase the transparency in reporting about who benefi ts from a mine or a facility


10Fraud and corruption

(same as 2011)

Fraud and corruption continues to be a signifi cant 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 company’s 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.

New regulationsNew 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.

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 offi cials• 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.

All completed UK bribery and corruption cases(2008–2011)

Actions against individuals(number of individuals involved)

Actions against corporates (number of corporate involved)

2008 5 1

2009 0 3

2010 7 3

2011 11 4

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 Offi ce (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 benefi t 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 specifi c 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 specifi cally to detect these issues.

Compliance monitoring is becoming crucial with many companies seeking assurance of their compliance, specifi cally in emerging markets. There is an increasing recognition that external advisors


“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.”

Paul FontanotFraud Investigation & Dispute Services, Oceania Managing Partner, Ernst & Young

41

can contribute to the effectiveness of a company’s compliance management system, and the recent issuance of a German assurance standard dedicated to this issue has received much attention.

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 offi cials and the management of third party contracts. Some of the leading practices in these high risk areas include:

• Targeted policies and procedural guidance (political and charitable contributions, travel, facilitation payments, etc.)

• Established third party due diligence protocols, including an assessment of a third party’s 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 liabilityA 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 benefi ted the ultimate customer, even without the knowledge of the ultimate customer.

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.

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 specifi c 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.

Whistle-blowing 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 fi 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 & Young’s 2012 Global Fraud Survey, 53% of respondents had established a whistle blowing hotline.

OutlookAs 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.


• Know and understand the key anti-corruption and bribery laws and their reach globally

• Become familiar with the accepted standards and guidance for designing and effective compliance program

• Conduct a corruption risk assessment• Design and implement the anti-corruption compliance program

• Monitor your anti-corruption compliance program, through programs such as Anti-Bribery and Corruption Data Analytics

• Incorporate anti-corruption compliance program into M&A and joint venture due diligence

• Periodically reassess risk and modify the anti-corruption and bribery program


Under the radar01 Resource nationalism

02 Skills shortage

03 Infrastructure access

04 Cost infl ation

05 Capital project execution

06 Social license to operate

07 Price and currency volatility

08 Capital management and access

09 Sharing the benefi ts

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


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 fl ag it as the risk which is likely to increase in prominence.

The focus on energy supply and energy mix is based on concerns about rising energy prices, energy security concerns and sustainability goals. Increasing affl uence 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-specifi c 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 signifi cant 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 fi 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 specifi c 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 signifi cantly, 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 diffi culty 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, 20112 Mining in Chile: a report by Global Business Reports, Engineering & Mining Journal, March 20123 Refi ning IFRS — Managing the risk of joint ventures, Ernst & Young, 2011

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

12Working with joint venture partners(new)


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 defi ne 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 confl ict 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; fi 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 company’s 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-effi cient technologies, such as effi cient 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 fl 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 fl ooding events) and reassess viability.

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.

4 Draft Upper Hunter Strategic Regional Land Use Plan, State of New South Wales through the Department of Planning and Infrastructure, March 20125 AngloGold Ashanti Sustainability Report 2011, 16 March 20126 Rio Tinto invests US$518 million in autonomous trains for Pilbara iron ore rail network in Western Australia, Rio Tinto news release, 20 February 20127 Rio Tinto expands Mine of the FutureTM programme with new technologies in underground tunnelling and mineral recovery, Rio Tinto news release, 21 February 2012

13Competing demands for land use(new)

14Climate change concerns(down from 13 in 2011)

15New technologies(up from 19 in 2011)


16Increased regulation(up from 17 in 2011)

17Pipeline shrinkage(down from 15 in 2011)

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 fi 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 confl ict free minerals independent verifi cation, 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 signifi cant 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 signifi cantly 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 greenfi eld exploration are, however, struggling to get fi 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 sector’s 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 diffi cult 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 infl uence 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.

8 Doing Business 2012: Doing business in a more transparent world, The World Bank and the International Finance Corporation9 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 specifi cally exclude exploration budgets for iron ore, coal, aluminum, oil and gas, and many industrial minerals10 World exploration trends 2012: A Special Report from Metals Economics Group for the PDAC International Convention, Metals Economics Group, March 201211 Mergers, acquisitions and capital raising in mining and metals: 2011 trends 2012 outlook, Ernst & Young, February 2012

18Consolidation(down from 14 in 2011)

19New communication vehicles for community activism(down from 18 in 2011)


Getting prepared


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 specifi c 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 & Young’s 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 fi nancial. There are steps that company leadership can take to address these issues:

• Conduct regular risk assessments that defi ne 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 fi 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 company’s 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.

How well are the risks and risk appetite defi ned, communicated and understood at your company? If you’re not sure about the answer to that question then chances are your company needs to examine its risk profi le with some urgency.

Is your company adequatelyprepared for risk?

Ernst & Young’s Global Mining & Metals Center 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 effi ciency 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.

Ernst & Young’s 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. It’s how Ernst & Young makes a difference.

Area contactsGlobal Mining & Metals LeaderMike ElliottTel: +61 2 9248 [email protected]

OceaniaScott GrimleyTel: +61 3 9655 [email protected]

China and MongoliaPeter MarkeyTel: +86 21 2228 2616 [email protected]

JapanAndrew CowellTel: +81 3 3503 [email protected]

Europe, Middle East, India and Africa LeaderMick BardellaTel: +44 20 795 [email protected]

AfricaWickus BothaTel: +27 11 772 [email protected]

Commonwealth ofIndependent StatesEvgeni KhrustalevTel: +7 495 648 [email protected]

France and LuxemburgChristian MionTel: +33 1 46 93 65 [email protected]

IndiaAnjani AgrawalTel: +91 982 061 [email protected]

United Kingdom & IrelandLee DownhamTel: +44 20 7951 [email protected]

Americas and United States LeaderAndy MillerTel: +1 314 290 [email protected]

CanadaTom WhelanTel: +1 604 891 [email protected]

South America and Brazil LeaderCarlos AssisTel: +55 21 2109 [email protected]

Service line contactsGlobal Advisory LeaderPaul MitchellTel: +86 21 2228 [email protected]

Global Assurance LeaderTom WhelanTel: +1 604 891 [email protected]

Global IFRS LeaderTracey WaringTel: +44 20 7980 [email protected]

Global Tax LeaderAndy MillerTel: +1 314 290 [email protected]

Global Transactions LeaderLee DownhamTel: +44 20 7951 [email protected]

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This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

The views of third parties set out in this publication are not necessarily the views of the global Ernst & Young organization or its member firms. Moreover, they should be seen in the context of the time they were made.

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Report: "Business risks facing mining and metals 2012–2013"

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