Mounting cost pressures are causing the mining industry to rethink its tactics. That’s not such a surprise in a global landscape driven by geopolitical fissures such as war, commodity market uncertainty, pandemic-related supply chain pressures and labour constraints – not to mention sky-high inflation.
According to Andrew Hall, Director/Executive Lead, Advisory at AMC Consultants, high metal prices have triggered a chase for production, compounding a fundamental scarcity in experienced and skilled labour, and pushing up costs for most of the last decade. “But in recent times, cost increases have been accelerating.”
The impact of war
Following the invasion of Ukraine, the world’s communities drew together to express their distress and provide support, but it’s hard to quantify the ramifications for the mining sector. Have there been many implications so far, and are they linked only to the conflict?
Hall isn’t convinced: “Certainly not the most significant factor for metalliferous mines – prices were already relatively high and costs have been increasing steadily for a while.”
David Vink, Advisory Lead, says the war in Ukraine, which had commenced in February, did not have a negative impact on industrial, base, battery, or precious metals each of which had continued their upward movement and were at a five-year high in May.
Energy commodities, oil, gas, and coal, which had fallen to lows during the peak of the pandemic, were experiencing a significant post-covid economic recovery-driven price rise before the war.
When sanctions were imposed on Russian oil and coal exports and Russia responded with gas supply restrictions the price of these commodities pushed to record highs.
He points out that metallurgical coal prices in July were forecast to average $420 per tonne in 2022 driven by increased levels of steel production but were settling around $270 in September; paradoxically a lower price than thermal coal at the time
Metals present a different story and are perhaps a better indication of what’s happening in global economics, says Vink. After a long run of increasing prices nickel and copper prices fell by 30% and 20% respectively in June, reversing bullish demand expectations in economies recovering from the pandemic. Most recently concerns have shifted to central bank efforts to contain inflation with interest rate rises and the dampening effect this will have on commodity demand.
Whilst prices were rising the costs of mining also increased and if prices continue to fall miners may begin to see their margins squeezed. It was OK when the prices were rising in lock-step, but some commodities are now seeing significantly lower prices but the costs have not fallen as much.
“Iron ore is back down to around $100, from a peak of $225, so people may be thinking: ‘The good days are coming to an end. Prices are falling from their highs’,” says Vink. In terms of precious metals, he asserts that gold has dampened too, off highs of ~$USD 2000, down to $USD 1638 in October.
Many companies incurred cost increases while upping production, with some taking the decision to reopen lower grade mines. As the tide goes out, operators will face an erosion of profits, which they’re keen to prevent. “A lot of miners will be thinking, ‘I got a little slower and heavier, over the good times. Now I need to work out how to get lean and fast again, and I’m not [currently] there’,” says Vink.
The narrative behind cutting costs
So, why is cutting costs labelled as a short-term approach? Firstly, Vink says, it’s worth bearing in mind that “the highest quartile cost producers are the most exposed in a downturn.”
Miners need to keep an eye on their costs in relation to peers and stay competitive. This is because “highest cost producers fall off the cost curve first. Their’ reduced output is the adjustment that’s needed in the global market to restore the balance between supply and demand, after which prices begin to recover.”
Unfortunately, this sometimes translates into simplistic cost reduction strategies, which Vink compares to a blunt instrument. For example, a business unit level percentage operating cost reduction “when a strategic and more targeted approach could be more effective. Other short-term measures such as overburden reduction in the case of an open pit, or development in advance reductions in an underground mine can buy time but at best provide only a temporary solution” he points out.
“With each of these measures the operation is not set up for success; it hasn’t truly reduced its unit costs, just deferred the problem into the future.” Resources are removed and the mine can no longer do what’s required to sustain the operation.
During high commodity price cycles, companies tend to increase their costs too much, then during tough times they cut more than they should, which may look good on paper but it’s deceptive, “because those cuts come back to bite you”, says Francis McCann, General Manager, Toronto, of AMC.
Granted, there may be some areas where minimizing costs is a good idea, but companies usually slash more deeply than necessary, which creates future issues, asserts McCann. “Because you’re cutting back on manpower and maintenance – and, as David says, you may be cutting back on some capital development for open pits or underground mines. And those catch up with you eventually.”
Why a simplistic approach isn’t always best
Hall cautioned against the use of simplistic measures. He points out that most costs are associated with maintaining capacity and capability and are relatively fixed, so simplistic cost-cutting measures are often not effective. A mine should be looking to right size. “That typically requires some deeper understanding of how mines work and where the margin comes from. The key point is there are two parts to the cash flow equation: costs and revenue.”
The biggest opportunity comes from getting the mine’s overall capacity right in terms of metal production rather than ore tonnes. This requires consideration of both production and head grade and understanding the two are inversely proportional. Most mines use break-even grades as their cut-off, and as a result when prices go up, they drop their cut-off grade and reduce head-grade. When mines expand to increase production during periods of high metal prices, we typically see the average mined grade fall and higher fixed costs, associated with maintaining greater production, get locked in. So, when prices fall their margins are squeezed.
But the opposite should be happening. There’s a chance to increase margins and de-risk the operation to counter rising costs and falling prices.
“We’re seeing margins being squeezed at the moment, with costs moving up and prices coming down – this is something that happens cyclically in our industry” says Hall.
A measured response
Savvy owners will adopt a more comprehensive approach and select strategies most suited to their unique circumstances. Some operators will try to increase margins when confronting falling prices, predicts Hall. “Operators who develop a deep understanding of their financial drivers will be best positioned to make a change; and then when they do, they’ll be more surgical in their approach.”
Having developed a solid understanding of their revenue and cost drivers they’ll already know the areas that need attention, shifting away from one-size-fits-all unsustainable cost-cutting to address the cause of high unit costs in the first place. And in doing that, it will be more sustainable.
“Agile organizations will make improvements very quickly addressing planning deficiencies and lower than benchmark equipment productivities to address the cause of higher than peer costs. When AMC reviews these performance metrics at a mine, we often find opportunity for improvement in the fundamentals such as shift utilization and reduced operating delay,” says Hall.
We also see opportunity in the way mines are exploiting their resources through a better understanding of mining methods, dilution, recovery, and cut-off grade, says Hall. “The way in which the mining process is conducted, mining practices, can be a major contributor toward higher than necessary cost and inefficiency.”
Improvements like these are a small sample of the hundreds of opportunities available to operators seeking to address higher cost and sustain their margins.
Experience pays off
Mature operators are more likely to see sense as they have been here before, asserts McCann. “However, I do caution that even those companies tend to react with, in my experience, an immediate need to reduce costs.” They become too distracted by the numerator of the equation – the dollars being spent, he suggests.
McCann points out that to increase margins beyond focussing directly on costs within the numerator, “you need to improve your denominator, by increasing product produced through improvements in operational productivities, utilizations, and availabilities, for example. However, those do take a bit more time to enact.” Such gains would take around six months to be reflected in reported data as they take time to implement, he says, yet “unfortunately, the way that the markets work nowadays is, ‘No – I need it done in this quarter’. So, they attack the numerator and reduce the dollars.”
This again raises the salient point of cost versus margin improvement. “However, the savvy operator will know that they must always keep themselves fixed on the denominators: those occasions when the ounces and the pounds of material are moved or produced. Those are the drivers,” he says. “They have to keep their eye on the ball and maintain, optimize and maximize during the life of an operation.” Refocusing through a far-sighted lens should be a consistent shift in approach.
As far as AMC’s clients are concerned, Hall’s key advice is to start early and be strategic in these times to avoid knee-jerk reactions presented by cost cutting and other value destroying measures that can be put in place through short-termism. “Our role is to ensure that mines have the right strategy and align their business goals with what is happening at the face, to maximise margin at all points in the commodity price cycle.” This will ensure they’re well-placed to beat any upcoming challenges, he says.
AMC doesn’t claim to predict how prices will pan out going forward, but “with the right strategy, you give yourself the best opportunity to reap the full benefit of high returns during the upswing,” says Hall. He also suggests that selecting the right strategy can also de-risk the operation during downturns as well. “That message is getting through because many mines are feeling the pain at the moment. So, for them, it’s a real opportunity to change their strategy so they continue to prosper.”
Sources:
1 http://www.kitcometals.com/
2 https://www.iea.org/news/natural-gas-markets-expected-to-remain-tight-into-2023-as-russia-further-reduces-supplies-to-europe
3 https://www.mining.com/coal-price-renaissance-how-long-can-it-last/
4 https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/base-metal-prices-plummet-amid-growing-recession-demand-fears-70933608
