Supply constraints remain many commodities' key driver - E&Y

Mining’s demand outlook remains strong, and with the policy-induced soft landing in China, the picture for mining coming into next year is bright—says Ernst & Young.


Author: Dorothy Kosich
Posted: Monday , 03 Dec 2012


“The fundamental demand story for mining and metals remains strong and we are already seeing an increase in growth in the Chinese economy, with expectations that this will be maintained in 2012,” says Ernest & Young’s Global Mining & Metals Leader, Mike Elliott.

“While we remain confident in the outlook for demand, we are more concerned about how the current hiatus in new capital approvals will impact future supply,” he added. “Supply constraints remain the key driver for many commodities in the medium to longer term, particularly iron ore, copper and lead.”

“There will need to be higher price signals to attract investment for new supply to meet longer term demand,” he stressed.

In a news release issued today, Elliott suggested the “volatility created by the global economic roller-coaster over the past 12 months, and the cost blowouts in the sector from the rapid expansion in recent years has created a very different operating environment for miners coming in 2013.”

“The volatility has created greater risk aversion by shareholders who have increased the pressure on mining companies to deliver committed projects more efficiently and not spend capital on new projects or investments,” he said. “This creates other challenges for miners looking at how they achieve longer term growth plans—they have the cash but not shareholder permission to invest.”

In addition to cost competitiveness and project execution, key focus areas for mining globally next year will be recycling capital for growth, managing local community stakeholder relationships, and balancing capital restraints with Foreign Direct Investment (FDI) obligations, Elliott noted.

Cost competitiveness and tighter discipline around project execution and operational effectiveness have become a key issue for miners globally, E&Y advised.

“The mining sector has been very production-focused for most of the past decade and quite quickly that has change where cost is now a much greater restraint and this is requiring a re-think in project execution. Every project has to be more cost competitive because it is the marginal projects that will be shut down first,” said Elliott.

“The companies that achieve sustainable, long-term improvements in productivity and capital project execution will be best positioned to take advantage of opportunities when new capital investment returns,” he stressed.

Meanwhile, miners needing capital for growth will be focused on recycling existing capital by divesting non-core or underperforming assets to free up capital for investment, E&Y advised.

 “As capital investment constraints on the larger diversified miners limits the amount of new capital that can be directed to lower the operating costs of high cost mines, these mines will be more valuable to prospective buyers who are not restricted in investing new capital,” Elliott observed.

“There will be many companies walking a tightrope around ‘use it or lose it’ clauses in their incenses, while not wanting to over-commit to new capital spending,” he noted. “We’ve already seen Tanzania announce a review of 300 licenses on this basis.”

E&Y suggests the emergence of ‘sharing the spoils of the resources boom’ as a key mining risk will also see a greater focus on community stakeholder relations.

“Miners are re-doubling efforts to maintain constructive relationships with local community stakeholders to avoid igniting issues that can quickly become claims to redistribute the benefits of the mine,” Elliott said. “In many parts of the word—notably in Peru—what may be initially regarded as small, local issues have provided a catalyst for a broader range of claims over access to wealth generated by the mine that can destroy project value.”