If one looks at long term charts of most metal prices one sees a very distinct cyclical pattern. When metal prices are high this stimulates new mine development, but unfortunately it is the nature of things that the new mines all come on stream at or around the same time, give or take a couple of years, the metal moves into surplus and prices then fall back. Profitability may be decimated, uneconomic operations close down, some never to reopen, global production falls, prices rise and the cycle repeats.
Most mining companies understand this process well, although a prolonged period of high metal prices, as we have seen over the past few years, tends to lead to the basic premise being forgotten—driven particularly by the short termism which is apparent in the financial community. Stock prices rise as the miners make bigger profits, institutional shareholders press for more production which they see as leading to ever higher returns, banks make lending to build new operations easier and more competitive, the high stock prices make raising equity capital easier, and the miners get carried away in the general euphoria and commit to horrendously costly new projects, while costs tend to escalate out of normal control. The companies can seemingly do no wrong—until the crash comes!
This last time round was no exception. Companies began to believe the hype about the seemingly endless supercycle, driven in particular by ever accelerating Chinese growth and the Asian dragon's seemingly insatiable demand for metals, alongside emerging market growth in the other BRIC countries and elsewhere. But all good things come to an end. For industrial metals China has stuttered, Western economies have turned down sharply, while in precious metals what appear to be market shenanigans have seen gold and silver fall back heavily at the same time as industrial metal and mineral demand has been cut. Even so, output for most industrial metals has been high as the new projects, entered into over the past decade have come to fruition. The whole situation has been exacerbated by governments, also driven by short termism, attempting to claw out ever larger slices of the mining cake—a cake that is being rapidly eaten away through other factors.
Suddenly, the miners find themselves on the back foot. Profits and stock prices fall, they are castigated by institutional and individual shareholders who had earlier been calling for expansion, for not foreseeing the structural changes that were about to occur. Boards, which had perhaps been wholly supportive of the previous growth for growth's sake consensus suddenly start seeking scapegoats. CEOs fall and are replaced by perhaps more risk-averse executives. Capital projects are deferred or cancelled, exploration expenditure is cut—and this is just at the top end of the mining sector. Further down the food chain things are even more dire with mid tier and junior miners perhaps not having the financial strength of the majors to see them through, while junior explorers—the source of many of the industry's future projects are folding, or cutting back expenditures to close to zero due to lack of funding and just to stay in existence until the cycle picks up again and prices start to rise. For many this cyclical upturn will be too late arriving.
And so the cycle repeats. Production will fall, new projects are delayed, sometimes indefinitely, the exploration pipeline of potential new projects is cut to a minimum. But meanwhile global growth will start to recover—China is still growing at around 7% a year for example and other emerging markets will be growing at similar rates. Even some Western economies are beginning to see signs of a return to growth, albeit at a very low level. But the net result will be that shortages of some metals and minerals will start to occur, prices will be driven upwards again, money may start becoming available for new mine development. The downsized miners will be leaner and more efficient, exploration will start to pick up again—all preparing the way for another cyclical peak some years ahead—one which will undoubtedly end much as the current one has done, but at a time when memories of what has happened in the past couple of years have diminished.
Thus, in an ideal world, now is the time to start building new mines to take advantage of the full cyclical recovery when it occurs. But financial strictures and a lack of capital mean that, for the most part, this is not happening. Yes, the mega miners with major projects already under way will have the financial strength to continue with them—major examples are the big Australian iron ore expansions by Rio Tinto and BHP which are well under way. The companies are being criticized in some quarters for continuing with these in the light of a projected downturn in iron ore prices, but their operating margins are big enough to remain profitable whatever the market throws at them in terms of lower prices and they will generate praise when the cycle picks up again in a few years time and they can fully service a growing market at higher prices again.
There are many companies out there that understand just how long the lead times are from exploration to production, indeed a major new mine, where an initial development decision is taken today, may not actually produce metal or mineral until the next cyclical upturn is already well underway by the time scoping studies, feasibility studies, host government negotiations, environmental assessments and approvals, permitting, financing, etc. have been completed and construction is actually in progress.
But, bringing a significant new mining project into production these days can cost upwards of $1 billion (sometimes many times that for a really large development likely to have an impact on global supply) and in the more risk averse financial environment currently prevailing it can be exceedingly tough for all but the most financially strong companies to raise the necessary money. The amounts concerned are usually beyond one company's capabilities to raise from internal sources and stock prices are perhaps too low to equity finance a project. Indeed the more cautious boards, even at the biggest miners, are looking much more closely at mega project capital costs with the result that these may not see the light of day until mid-way through the next cyclical upturn.
Lawrence Williams
Mineweb
