Over the past year, we’ve seen companies struggle with the twin capital dilemmas of capital allocation decisions and finding access to financing. This is the result of two years of weak metal prices, labour unrest and rampant cost inflation, all of which have put pressure on earnings. At the same time, pouring peak levels of capital expenditure into major growth projects has left companies with squeezed margins and lower rates of return on many projects. Shareholders began to question the scope for increased capital returns without a decisive change of strategy by management, and available financing seemed to disappear quickly.
These issues topped EY’s annual Business Risks Facing Mining and Metals 2013-2014 report after sitting in the eighth spot in the prior year.
We’ve already seen the effects of these challenges play out in the industry in the form of delays of capital projects, divestments, mergers and acquisitions. Companies that take a proactive approach to portfolio optimization and seek alternative — and creative — sources of financing will best weather the current capital strike.
This isn’t the only challenge facing mining and metals companies. Effective risk management means addressing all of this year’s top 10 risks in the sector.
Margin protection and productivity improvement
The market is shifting its focus on growth towards long-term optimization of capital with sector-wide redundancies, mine closures and divestments of non-core assets in an effort to address the challenge of margin protection and productivity improvement.
Resource nationalism — our number-one risk in 2012-13 — has moved down the list as companies have become more adept at managing this risk. Leading companies are building stronger relationships with governments and effectively communicating positive industry impacts.
Social licence to operate
Earning a social licence to operate is becoming increasingly important as regulators seek to fill the gap between community expectations and existing laws. The key to maintaining and achieving a licence is to communicate the concept of shared value to all stakeholders.
Skills shortage has fallen down the list this year as mine closures have reduced the need for skilled workers. As projects ramp up, so will the need for skilled workers. Companies can take steps to mitigate this risk by adopting creative and innovative approaches to access new pools of talent, leveraging technology and retaining existing skilled workers.
Price and currency volatility
Demand for commodities driven by rapid-growth economies has outstripped supply, fuelling higher prices and change in supply. This has caused an increase in price volatility. This risk is becoming a challenge for many commodities, specifically gold and nickel. Documenting the volatility of critical cash flow elements and improving planning are steps companies can take now.
Capital project execution
Over the last two years we’ve seen a number of highly publicized mega-projects cancelled, with others delivered late or over budget. Now with capital challenges knocking at the door of majors and minors alike, companies are increasing their focus on portfolio management, project selection, size and scoping decisions.
Sharing the benefits
Today’s risk-averse stakeholders are demanding greater returns despite falling commodity prices and higher costs. Miners can address stakeholder concerns by increasing transparency when it comes to stakeholder benefits.
To meet infrastructure demands, companies must reassess their needs and revise their strategies, especially in light of recent high costs and capital constraints. A new model of risk transfer and retention will be necessary to unlock badly needed financing for infrastructure projects.
Threat of substitution
Substitution is a growing threat for single-commodity organizations, or organizations where one commodity dominates the product mix/profit share — and is a new addition to our risks list this year. Mitigating this new risk begins by keeping an eye on government regulations and actively participating in sector discussions around policy changes.
Despite an increase in the risk environment over the last year, conducting regular risk assessments and proactive scenario planning will enable your company to develop a better understanding of the issues and opportunities to come.
Visit us at ey.com/ca/mining and follow us on twitter @EYCanada.