Summary. The confidence of the energy and resources industry has been shaken by the pace of change that began with the global financial crisis in 2008 and was exacerbated by the COVID-19 pandemic and the climate change threat. Competitive tensions between operators and suppliers, with owners squeezing down margins and transferring risks to their suppliers, created a culture where the resource pool for major projects was reduced. But global warming and the now urgent need to transition to clean energy infrastructure are likely to bring about a supercycle of prolonged investment in the journey towards net zero, as the demand for capital projects to expand the volume of transition commodities starts to accelerate.
In previous supercycles, metal and energy demands exceeded capacity, pushing pricing and capital project investment to record highs. What we see on the road ahead is history repeating itself: another supply and demand imbalance that will require savvy operators to get in front of the curve and secure their supply chains. But is the industry ready to modify its former adversarial tactics and maximise collaboration between owners and suppliers for the purposes of mutual gain?
The key to a successful collaboration is in aligning all major stakeholders behind a common set of goals and taking a long-term approach. It’s in the interests of the sector to manage risks and costs efficiently and fairly, in ways that owners and suppliers may never have done before, and to do so sustainably.
How net zero and a prolonged supercycle will impact supply for the resources sector. By Dr Alan Monaghan and Nick Bell.
In 2007 the global energy and resources markets were in the middle of a synchronous peak that created record returns and capital investment, and unseen demand for skills and equipment.
Between 2002 and 2008 the price of iron ore leapt from US$29 per tonne to US$195 per tonne (IndexMundi). While grade-A copper jumped from US$1,600 a tonne in 2002 and to almost US$10,000 a tonne by 2011. The same story was repeated across most industrial metals, with booming demand causing the price of lead to increase from under US$500 a tonne in 2002 to almost US$4,000 a tonne five years later. Other markets were not spared, with crude oil rising from US$65 to $265 per barrel between 2002 and 2008.
Despite the impressive revenues this generated for miners, the boom created cracks in the industry’s foundation. Many regions experienced unsustainable competition for project resources, including engineering and project delivery expertise and skilled trade/craft labour for manufacturing and construction.
Demand drove capital cost escalations and project delivery prolongations which eroded and sometimes destroyed respective business cases. And surge pricing brought lesser skilled teams into the project delivery market, resulting in lower productivity and increasing hourly rates.
Competition also drove up average labour costs on projects from 35 per cent (Merrow [1]) to 50 per cent (Findley and Wallace [2]). Combined with material and equipment escalation, this contributed to project costs increasing on average by 100 per cent (Hollman and Dysert [3]).
Fourteen years may seem like a long time ago. And it’s easy to underestimate the lessons we’ve learned as we prepare for the future. But it’s these outcomes that have led to the strong
capital discipline the sector deploys today, as owners sought to reduce the risks associated with poor delivery, while profits increased for service providers.
We learned a lot from the prosperity of the last boom, but also the bust.
In this article, we examine the impact of the post global financial crisis (GFC) trough and the culture shift that’s created tension across the resources industry, including oppositional tactics from both owners and suppliers.
By drawing on the lessons learned, we look at why this imbalance needs correcting as we approach the next wave of investment. This includes mitigations across the supply chain, people and labour, and joint ventures.
Addressing these can help rebuild relationships and drive greater collaboration as we face the biggest challenge of our time: the energy transition.
[1] SPE Houston – “Cost, Profit and Risk: Understanding the New Contracting Marketplace”, 2007
[2] IPA Industry Benchmarking Consortium – “Market Trends: A Focus on Engineering Productivity”, 2008
[3] AACE International – “Escalation Estimation: Working with Economics Consultants”, 2007
The global financial crisis shocked confidence across the supply chain
Unlike the earlier extended supercycles, such as the post-World War II recovery, the 2000s boom was cut short by the GFC in 2008. It negatively impacted all commodities and suspended or mothballed many of the projects in the design phase.
Service and construction providers across the globe were decimated with the abruptness of this decline. Even for an industry that’s used to the effects of economic cycles, the pace of change shook the confidence of both owners and service providers.
The severity of this change on the supply chain for major projects reflected the competitive tension that had grown between operators and suppliers.
The impact on supplier margins and the assignment of risks was amplified by the repeated cycles of boom and bust. And the previous cycle’s lean margins and extreme risk allocations on suppliers created a culture where they needed to repair balance sheets and maximize margins where they could find them, adding to the increasing costs for owners during the boom.
The market seemed ‘in sync’ but in an unhealthy way.
Post global financial crisis: a smaller resources pool
Post-GFC, the owner’s procurement processes responded by driving suppliers back into a period of extreme austerity. They squeezed down margins and transferred a disproportionate amount of risk back to a group of stakeholders who were least prepared, both economically and technically to accept either.
Consequently, many service providers either exited delivering projects in parts of the value chain (particularly where lump sum pricing was demanded) or merged to shore up weak balance sheets.
This over correction in commercial influence to balance the risk to reward equation resulted in the resource pool for major projects being reduced, as many service providers did not survive the impact.
On the cusp of the next wave, and with these lessons vividly in our minds, the forced austerity of the service market and suppliers of the last decade will influence an opportunistic response on profit margins if the status quo and its associated tension is retained.
The energy transition: mining’s next wave of investment
Historically, supercycles have been triggered by a major investment initiative. For example, the industrialization of the US, post-World War II economic recovery, and the Asian investment stimulus post SARS. These all led to metal and energy demands that were in excess of capacity, pushing commodity pricing and capital project investment to record highs.
But today an alignment of drivers, potentially even more significant than the last cycle, is influencing current forecasts for investment which could dwarf the project delivery demand experienced previously. At the heart is global warming and the energy transition, which are impacting all sectors and magnifying the size of the challenge that lies ahead.
Goldman Sachs [4] has argued that the 2020s sees economic structures at play like those that drove the last boom at the turn of the century. Mark Lewis [5], the chief sustainability strategist at BNP Paribas Asset Management stated that the next 30 years are “likely to bring a supercycle in investments in clean energy infrastructure, clean transportation and everything else that’s required to make the green transition possible.”
[4] Goldman Sachs – “2021 Commodities Outlook: Revving up a structural bull market”, Nov. 18, 2020
[5] Resource Global Network, “Growing Cadre of Analysts Pointing to Imminent Commodities Supercycle”, Feb 19, 2021.
COVID-19 impact
COVID-19 provided the intervention required to demonstrate just how much human activity is impacting global CO2 levels. Since the beginning of 2020 there has been a groundswell of both governments and private companies embracing climate change and decarbonization commitments. This trend is now irreversible.
With intermediary targets laid down for 2030, and net zero targets set for 2050, the demand for capital projects to produce the expanded volume of transition commodities is expected to accelerate and continue for the next 29 years.
This will return the resources sector to a market with a significant imbalance between the supply and demand of commodities, construction materials, specialist equipment and skills including project and construction resources.
We’re already experiencing strong pricing from iron ore, copper and lithium. However, the services sector is still in a diminished state from the last downturn, compounded by the increasing social pressure that impacts the brand of the resources sector.
While manufacturing and even some mining projects can accelerate and ramp up supply in periods of five or 10 years, a parallel increase in the pool for engineering and project delivery expertise has a much slower gestation period.
With an extended boom period on our doorstep, is the industry ready to modify and change the adversarial tactics used in past supercycles? Or is there a better way to reduce the tension and maximize collaboration for mutual gain?
Lessons to consider for the next supercycle
Supply chain mitigations
If we acknowledge the impact traditional supply relationships can have during cyclical markets, sitting back and waiting for supply and demand curves to affect project costs and schedules in the next boom isn’t a recommended strategy.
However, mitigations with supply chain providers have been successfully implemented for decades. For example, in the 1990s a shortage of large mining vehicle tyres from Japan saw companies stockpiling and pushing out supply times past a year, resulting in an emerging secondary market with high spot pricing. This shortfall of supply extended into the new millennium.
Ten years ago, Caterpillar shared its mitigation plans to build closer relationships with suppliers to secure their supply chain needs in the hyper-competitive market (Curfman [6]). They were caught out with supply shortages in the previous decade, leading to delays in customer equipment orders. In response, they actively changed their supply relationships and strategy to be better prepared.
Even today, as the new market pressures highlight the need for energy transition minerals, companies like Tesla and Volkswagen (who have committed their future production exclusively on electric vehicles) are negotiating supply agreements and relationships further up the supply chain to secure essential battery minerals such as graphite and lithium.
[6] Chris Curfman, Caterpillar Global Mining President, CRU copper conference, Santiago Chile 2011
People mitigations
Analysis of the last supercycle found that the focus on commodity and equipment pricing alone didn’t address the primary driver of cost escalations. Even in regions with low levels of project competition, demand for engineering and project delivery resources saw hourly rates increase from 10 per cent to 25 per cent between 2003 and 2007, and skilled trade/craft labour rates increase from 45 per cent to 100 per cent (Merrow [7]) during the same timeframe.
This supply and demand imbalance shifted negotiation power to the contractor. It resulted in higher contract margins, and the inclusion of risk pricing factors to transfer more cost, productivity and schedule risk back onto the project owner.
Given the widespread skilled labour escalations and prolongations experienced in the last cycle, it’s evident that skilled labour cost mitigations were not routinely introduced. However, they were studied for future learnings.
Independent Project Analysis [8] published training guidelines in 2008 highlighting the cost and success factors on their project database in various project team and commercial structures. Integrated teams with higher owner involvement and better quality of contracting resources outperformed the alternatives every time, often determining success or failure of the project and containing costs by over 20 per cent.
[7] Merrow, SPE Houston – “Cost, Profit and Risk: Understanding the New Contracting Marketplace”, 2007
[8] Independent Project Analysis – “Module 2 – Objectives, Teams and Staffing”, 2008
Joint venture mitigations
To address the supply of skilled project labour, joint venture mitigations have been successfully implemented. Over a decade ago, on the eve of a major capital expansion program, OCP Group in Morocco created the JESA Joint Venture, an equal partnership with Jacobs Engineering Group’s ECR Division (now Worley), to provide a sustainable project engineering and delivery capability for their ambitious capital program.
A decade later, the team is over 1,500 people strong. While remaining a collaborative engineering and project delivery partner for OCP’s capital investment, JESA has diversified. It now provides operational and maintenance support and efficiency improvement programs across the entire lifecycle of a project for a broad customer base in the region.
In the last cycle, standing out among the large project escalations seen across Australian resource projects, the BHP Mitsubishi Alliance (BMA) achieved envious project delivery results. It contained its capital costs increase to 10 per cent on average, compared to the Australian industry average of 44 per cent (ABARE [9]). Among their strategies for cost and quality control, long-term supplier agreements for both equipment and services were also key to BMA’s success.
The common element of these joint venture mitigation strategies was a fundamental change in the nature of the relationship between owners and suppliers. A shift from parties taking advantage during their more powerful phase of a boom-bust cycle in highly transactional relationships, to adopting a long-term view and building more collaborative relationships that sustain and support the industry.
[9] ABARE Australia Resource Project Quarterly Reports, 2004-2010, https://www.agriculture.gov.au/abares
A mitigation strategy for the future
In the lessons from previous supercycles, there has been a strong recognition across strategic companies to buy forward, stockpile and secure supply. Traditionally this has been more evident in the commodities, components and equipment necessary for capital projects and operational maintenance, than in the supply of skilled project teams.
However, in the last supercycle work was done to demonstrate the impacts achieved when alternative commercial models are used to engage both project engineering and delivery and construction supervision resources.
As we rapidly approach another supply and demand imbalance, it’s the savvy operator who is negotiating ahead of the wave and proactively locking in relationships to secure their supply chains.
Just as we’re currently seeing with construction commodities and equipment supply, opportunities exist to build the right commercial models that provide owners surety of supply for the quality and quantity of engineering and project delivery capabilities needed for their capital project pipeline.
The key to successful relationships is aligning all major stakeholders behind a common set of goals. Parties should be encouraged to manage and contain costs as far as the market allows. But the focus should not be restricted to managing the input costs of stakeholders. It needs to focus more on agreeing successful outcomes and aligning risk responsibility and rewards with achieving these outcomes. This is more likely to produce a shift in behaviours of all stakeholders and drive collaboration to overcome challenges on the journey to achieving a sustainable balance in the supplier market.
A collaborative, long-term approach will be critical to success
One aspect is clear. Steering away from traditional supply chain relationships to more collaborative relationships is key to smoothing project cost and schedule impacts during periods of boom and bust.
It’s not in the long-term interests of the resources sector for owner and service providers to concentrate on shedding risks and exaggerating margins. Both risk and costs need to be managed at sustainable levels.
Transferring risk is not a risk management plan, unless it’s placed into the hands of stakeholders who have the skills to manage it and have priced it into their model. It will not be a true collaborative relationship if either party resorts to profiteering from the misfortune of the other during the respective peaks and troughs of a cycle.
Only through a long-term approach, working together on a shared goal to provide the resources the world needs over the coming years, will we make the relationship between supplier and owner sustainable for all parties. And both affordable and manageable for the owners in peak boom times.
If we’re to meet the ‘never-before-seen’ expansion demands associated with the energy transition, we are going to need to collaborate and coordinate across all key stakeholders in a manner never previously envisaged, let alone achieved.
Dr Alan Monaghan is Senior Vice President, Technology & Expert Solutions at Worley Mining, Minerals and Metals and Nick Bell is Global Sector Leader at Worley Mining, Minerals and Metals.
