Mining industry inertia will come at a price
PwC's John Gravelle on the mining industry's austerity drive, price realities and declining exploration spending
The latest annual report by management consultants PwC about global trends in the mining industry shows just how sharp the decline has been.
Mine 2015 examines the 40 largest mining companies in the world and at just under $800 billion, their aggregate market value is now back to 2005 levels and half of what it was four short years ago.
The report titled The gloves are off also notes that despite a relatively stable gold market, 2014 was another year of heightened price volatility. It warns the stormy conditions in the sector may only intensify as supply and demand are knocked more out of kilter.
John Gravelle, global mining industry leader for PwC, tells MINING.com current weakness is probably more of a supply issue than a demand one, with many of the Tier 1 assets bought when the going was good now coming on stream.
Apart from a resurgence in demand – not expected in the short term – the only thing that could see prices spike is if more production comes off line, says Gravelle, adding that the realities of the current environment has now set in for executives and boards.
"Mining companies are now making decisions on where prices are now. They no longer consider, as they were a couple of years ago, the drops to be temporary and that prices are simply going to rebound 25% next year. If and when they do go up we'll be happy to increase margins, but in the meantime we'll make sure we can operate profitably at current price levels," says Gravelle.
Miners’ cost-cutting efforts were helped by falling oil prices and weakening local currencies last year, but much of those saving have been realized. Last year the top 40 miners by market cap lowered operating costs by 5% despite increasing production.
There's definitely more cost cutting to come and companies are having to innovate to find ways to do so, says Gravelle citing the examples of smaller players able to squeeze more out of the divested assets of majors: "If it's their only assets they get really focused and find new ways to save. "
Asset impairment charges were cut in half in 2014 from 2013's record tally but at $27 billion writedowns are certainly still eye-watering. As for a new wave of spending, that's not going to happen any time soon.
"Shareholders are just not letting companies do the big acquisitions. The mining companies would like to do the groundwork in order to take advantage of the next upswing, but the reality is that shareholders still remember those big write-offs.
"They're saying let's not go back there again – show us you can operate profitably with what you have. Once they've proven that to the market, that's when they start looking at the next opportunities. But, were just not there yet."
The top 40 companies slashed capital spending 20% in 2014, with most shying away from greenfield projects, focussing on a handful of tier-one projects or developing smaller brownfield assets.
Nowhere is shift away from an investment and growth mindset to austerity and shareholder returns more visible than in exploration budgets.
Over the last two years, the majors cut back their exploration spending by more than half to a "miserly" $4.9 billion in 2014. That's down from the $6.3 billion allocated in 2013 and $12 billion in 2012.
The report notes that the smaller exploration budgets at the 40 largest companies isn’t in itself a reason for concern for the long-term sustainability of the industry – the concern comes from the increasing difficulty of junior miners to raise capital targeted for greenfield exploration activities.
And that won't change unless the mid-tier and top producers start attracting capital back to the sector first, says Gravelle:
"You need to get investors excited about the mining industry overall. Once the mid-tier and major producing companies can show sustained profitability that's when you get some excitement back in the sector.
"The money will flow into low risk companies first. There's always going to be the investor that wants to get in early, but the junior market would only really start to benefit once producers have instilled investor confidence. And that may take a couple of years."
The industry’s inertia on exploration will come at a price PwC says in the report. If reserve levels continue to decrease, it may further exacerbate the demand and supply volatility witnessed in recent years.
The reductions in capital raised and spent on exploration also call into questions miners' ability to respond to eventual increases in commodity demand. A generous interpretation of current industry conditions and lack of ambition is that it is setting the stage for the next supercycle.
And while it's definitely a long term expectation and many factors would have to fall into place to make it happen, Gravelle believes three major trends will lead to a resurgence in demand:
Successful structural reforms in China, rapid Indian urbanization and infrastructure investment growth and the building of a new Silk Road which would dwarf even what China achieved over the last decade in terms of its impact on mining.