Mining industry enjoying ‘renaissance’: Deloitte

Many economies are progressively emerging from the global financial crisis (GFC), albeit somewhat tentatively. However, some sectors may be forgiven for postulating the GFC was more of a medium term correction than an all out crisis. Specifically, consider the resources sector, incorporating most metals as well as oil and gas. That’s not to say that commodity prices went unscathed over the period but rather that their collective strengthening on the other side of the GFC has been nothing short of impressive. Further volatility is expected but a modicum of sustainability is anticipated.
During the GFC, equity and debt became scarce commodities and where either one of the two was available it typically came at a very high cost. Liquidity in both the equity and debt markets largely dried up and hence anyone requiring funding was at the mercy of those entities with funds. Consequently, a number of companies that could not obtain funding did not make it through the GFC. Financiers were more than just extremely selective in where their new funds were exposed, they were generally avoiding funding any further developments.
The world has moved on and commodity prices have again reached strong levels. It could be expected that a commensurately high availability of finance is also on hand. However, it’s not that simple.
There are two main groups of resources companies in the market soliciting finance. There are those that already have operating projects and are seeking additional funding to expand existing production and then there are those exploration companies that are looking to bring their exploration targets into production. Each group offers different risks and, more importantly, different security and certainty for a financier, whether that finance is secured through equity or debt. Considering the recent past, incorporating the GFC, financiers are still somewhat reticent going into high-risk-high-return exposures, including early stage start-up and mining exploration companies. On the debt front, a few reasons for this include:

• the current liquidity of financiers is still stifled as firstly, balance sheets strengthen and secondly, governing central banks increase financial institutions’ required reserve ratios;
• the selectivity of financing opportunities. Well proven projects will receive attention and possible finance;
• the financial risk. Although this parameter is always given great attention, the GFC has forced some economies into deficit and a potential way to improve their position is to target, through royalties and taxes, higher revenues from the natural resources sector; and
• the project risk. Strong commodity prices can give historically marginal projects a new lease on life and numerous now-commercially attractive projects have surfaced and require financial support.
The equity markets are also cautious on where their capital is exposed. A few capital raising attempts have been discontinued over the last half-year although a few more have been successful. Other than some of the reasons highlighted above, the equity markets also give significant consideration to commodity price and exchange rate volatilities. However, that’s the nature of equity exposure and something that the markets factor into their investment decisions.

Good projects finding support
But it’s certainly not all doom and gloom. The investor markets have been gradually reopening for business and good projects are finding the necessary financial support to take them through expansions or new developments. These funding sources include private equity.
Of ever increasing importance for project finance is the continued growth of the Asian economies and specifically that of China. To support its most recently announced annualised growth rate in double digits, China has consumed and continues to consume vast amounts of natural resources, sourced ideally from Australia due to its proximity. To preferentially secure the offtake from producers, Chinese private companies and State Owned Enterprises (SOEs) have been procuring and proffering the funding necessary to bring resources projects into production and to expand existing producers’ production rates. This is ubiquitous in the iron ore sector of Western Australia and more recently in the uranium sector too.
A number of forces supporting behind renewed impetus in the resources sector post the GFC, some of which relate to financing and some of which are industry specific. All of these factors impact on the fundability of a project. In general, these forces can be broken down into the following areas:

• As stated, financing markets are open to small raisings for good projects:
While overall sentiment is improving, there has yet to be a successful significant capital raising. An ever increasing number of small raisings have occurred recently and these tend to be for well-defined projects that demonstrably lower risk profiles than their peers
• Debt continues to remain elusive:
New project developments are still rare based on available funding, but strategic investors are increasing their presence and obviate the need for bank-financing.
Financial institutions are likely to provide greater debt into the resources sector only once the financial markets have further stabilised. The perceived level of risk in the resources sector is relatively high and hence it will be one of the last sectors the banks fully reopen for business.

• China has been and still is eager to secure offtake through project or equity ownership or a combination thereof:
China’s SOE’s typically have access to funds. As China’s economic growth continues to exceed that of any other nation, its hunger for natural resources remains unsatiated. Since China cannot produce all of its own requirements, it has to secure access to resources offshore.
• Japan, Korea, Vietnam, India and other countries are also competing for projects and opportunities, further opening up the source of investment support:
As the world continues to emerge from the GFC, a number of countries have reflected on their own resource requirements over the foreseeable future and are increasingly securing their own sources of raw materials supplies.
• New mining projects are likely to be more remote, deeper lying, lower grade or metallurgically more complex (or a combination of these) and hence present additional technical challenges:
Most of the world’s near-surface, high grade, low risk deposits have been exploited or are known. New finds are generally in more difficult positions, technically, geographically and geopolitically.
• Insufficient industry skill has been and will continue to be a problem:
Not enough qualified people enter the resources sector each year to fill demand. Great operations in great locations generally secure the great skills. Once the leading skills base has been accounted for, the next tranche of available skills is placed in positions that, at times, may exceed their abilities. The unfortunate result is that under cyclical downturns, these operations and their operators are exposed and sometimes cannot survive.
• Climate change, environmental reporting, carbon pollution reduction scheme (CPRS) and emissions trading scheme (ETS) are additional factors requiring significant focus in the resources sector:
These factors will carry a cost when implemented. It is difficult at this stage to quantify what the financial impact on mining operations will be, but that there will be a negative impact is without doubt. Mining operations consume electricity, fuels and oils and produce waste products that need to be environmentally clean. The implication is that the cost of production will increase and these higher costs will manifest in higher cost products, passed on to consumers.
• Infrastructure availability in many areas (globally) is wanting:
Mining projects increasingly have to carry the cost of developing infrastructure in order to bring their projects to market. As projects become more remote from existing infrastructure, mining companies increasingly have to bear the cost of developing critical infrastructure. Typically the additional infrastructure required includes power sources, railway connections, port capacity, access to water and roadways.
• Intervention of politics in business, notably in natural resources:
While there are a number of positive interventions, generally it can be said that interventions can impact approval processes, introduces dictates, restrictions and limitations, financial imposts, and sometimes other negative consequences. Security of Tenure is generally subject to conditions which, if breached, may result in the limiting or rescinding of certain approvals. Generally it can be said that as (notably emerging) economies see the possible value of the development of their natural resources sector, they impose higher taxes and duties in order to receive more of the benefit. There are risks to this since, if there is inadequate return on a project for the capital providers, that project will not be developed and all parties ultimately lose out.
The mining industry is enjoying a renaissance. As global markets settle further, financial support for mineral project developments will increase. Survival has given way to optimism, development and growth.

Dr Eric Lilford can be contacted on tel: + 61 (0)8 9365 7279 or email: elilford@deloitte.com.au