Mid-tier producers grapple with Peru’s growing pains

VANCOUVER — Peru is undoubtedly experiencing a mining boom of global proportions thanks to years of growth and increasing production. The country is currently the world's No.2 copper producer, No.2 silver producer, No.6 gold producer,...

VANCOUVER — Peru is undoubtedly experiencing a mining boom of global proportions thanks to years of growth and increasing production. The country is currently the world's No.2 copper producer, No.2 silver producer, No.6 gold producer, No.2 zinc producer and No.4 lead producer, while ranking high in other commodities, too. The country averaged 6.8% annual growth between 2002 and 2008, while exports, of which mining accounts for about 60%, have grown from roughly $6 billion in the late 1990s to about $46 billion in 2011.

That growth shows little sign of letting up, with some $50 billion in investments lined up for mining projects and much of the country still under-explored.

But the rapid growth is creating new challenges for companies large and small trying to open and operate mines in the country. On a social level there is growing discontent as to how the benefits of mining have been distributed in the country, while on the operational side the mining boom has brought the global labour shortage to the country.

Rio Alto Mining and Fortuna Silver Mines are two of the few Canadian-listed companies that have successfully transited from developer to producer in the country. Both have faced these issues, and through a variety of approaches have overall managed to succeed despite them, continuing to ramp up production and for the most part increasing earnings.

Rio Alto, since restructuring in 2009 and listing on the Peruvian stock exchange, successfully commissioned its first gold mine, La Arena, in Peru's northwest district of La Libertad. The company started pre-production at the oxide mine in May 2011, produced 56,000 oz of gold in the first quarter of 2012 and expects to produce around 155,000 oz of gold for the year. Meanwhile, the company's stock price has gone from 7¢ in late 2008 to a recent 52-week high of $4.76, at a time when the vast majority of mining stocks have been declining.

In the past six years Fortuna has gone from being company with all of five employees to a mid-tier producer with two mines in operation and some 1,500 employees, including contractors. In the first quarter of 2012 the company produced roughly 953,000 oz of silver, 5,100 oz of gold, 4.4 million lb of lead, and 5.3 million lb of zinc from its Caylloma polymetallic mine in Peru's southern region of Arequipa and its San Jose mine in Mexico. Since late 2008 the company's stock price has gone from 38¢ to a high of $7.58 in late February.

But Fortuna's stock price was hit hard at the end of March, dropping well below $4 for a stretch, after several issues came to light in its quarterly results. The news that most affected the company's stock price was the higher costs it encountered in the quarter and its projections of 20% in cost inflation for 2012. According to Carlos Baca, investor relations for Fortuna, that cost increase can be blamed mostly on increasing labour costs.

Peru, isolated from the global labour crunch for some time thanks to its long established and deep talent pool, is now facing the same shortages as the rest of the industry.

Jorge A. Ganoza, president and CEO of Fortuna, said in a phone interview from Lima that he remembers hearing about skilled worker shortages in Australia and South Africa a few years ago but it wasn't affecting Fortuna's operations.

"We were in Peru and Mexico at the time and we didn't know what they were talking about. There were no shortages here. And then the shortages moved to North America, to the U.S. and Canada, and we were still immune to that. But now it's happening to us," Ganoza says.

Ganoza said he now sees big ads in the Lima papers from BHP, Rio Tinto, and the other big multinationals hunting for skilled labour, often looking for workers for their operations abroad in Australia or Africa.

"Peru has become a pool for talent, and that of course is putting pressure on us here as well," Ganoza says.

In response, Fortuna has implemented new compensation packages, but also moved to do things Ganoza says have not been seen in the industry in the past, like mapping talent in the company, determining key positions and issuing retention packages for key personnel. Without the vast resources of the majors it can be harder to manage human resources, but Ganoza says that for the size of the company, Fortuna has been very innovative in its efforts.

At Rio Alto, company president and CEO Alex Black said in a phone interview from Lima that the company has also seen labour costs increase, despite the country's talent pool.

"We're lucky because Peru is a mining country, so there is a lot of talent in-country. Having said that, we are seeing wage inflation in the mining sector because the country is growing and the mining sector is very lucrative."

Black says that Rio Alto is well placed to attract workers though, because Peru has an 8% profit sharing regime, and Rio Alto expects to be very profitable in the coming years as it continues to ramp up production.

"Workers will gain considerably from a successful operation," Black notes. He also added that with Rio Alto's La Arena mine sitting at a relatively low 3,500 metres, and within about 100 km of the coast and the city of Trujillo, it is more accessible and easier to attract workers than some of Peru's more remote mines. And the company's stock performance, helped by a stable Peruvian shareholder component, has given the company a higher profile that has also made attracting talent easier.

"It adds to our visibility and credibility, we're not just some junior company that just appeared. So that helps us attract people as well," says Black.

But while the labour shortage is slowly creeping up in the background, social unrest has been the glaring up-front challenge to operating in Peru. The high profile conflict surrounding Newmont Mining's $4.8 billion Conga copper-gold project is only the most visible of the many simmering social conflicts affecting projects large and small across the countryside.

Both Fortuna and Rio Alto have experienced social unrest in the past year, though both incidents were fairly isolated. Rio Alto had around 30 locals blockade a road to its mine in September last year, while just at the end of May the road to Fortuna's Caylloma mine was blocked by a few hundred in a 48-hour strike.

In Rio's case, Black says the locals did not really have particular demands, more seeking clarification of agreements already made and a show of strength. The illegal blockade prevented some 700 people from getting to work and disrupted operations at the mine, but the company decided to take the more patient approach.

"Instead of letting nature take its course and allowing the police to come in, we decided to instigate dialogue to let them voice their objections to get the blockade over and done with," Black says. It took a few days, but after the company agreed to form joint committees to monitor previous agreements, the blockade was lifted, while the community members agreed to start with dialogue before trying any blockades in the future.

Black also says that being near Barrick Gold's Lagunas Norte mine has actually made things easier for the company, since Barrick started off on the right foot when it arrived. He contrasted that with the Newmont's problems, which stem in part from a poor operational record in the past.

"Here in Peru, if you make mistakes, especially on the social side, those mistakes stick with you for a long time," Black says.

As to the Callyoma protest, Baca says locals actually blocked a main road intersection that affected several mines in the area in a show of force, while local media reported they were demanding more local infrastructure projects. Within 48 hours the roads were open again, but the overall lack of infrastructure spending in the countryside makes such protests likely to happen again.

A recent Reuters investigation showed that Peru's provincial governments are sitting on roughly $3.5 billion in mining revenue gathered over the past decade, but lack the capacity to spend it.

Ganoza has seen this problem first-hand, witness the rapid growth the country has seen in the past decade that has allowed the poverty rate drop by half to 27.8%, but left many people still not benefitting from the growth.

"We went from having a government without financial resources, to local governments having a large amount of financial resources available. So we need to catch up and learn to spend that money," Ganoza says.

The problem, says Ganoza, is not the mining companies themselves, nor even the mining legislation or system, just the need for better implementation of what's already established.

"In Peru we have an excellent mining code that I think should be an example to many countries. It's just the ability of the government to execute on existing laws ... We just need the government to be more effective in its use and distribution of state resources," Ganoza says.

Despite the challenges, both Ganoza and Black consider Peru one of the world's top mining jurisdictions. Ganoza says that Peru has not gotten any easier, but it still stands out as one of the best countries in Latin America.

"Where else are you going to go? In Chile, there is a shortage of power and water, Argentina today has become off limits for the industry basically with all this nationalism, Brazil has always been challenging and it's not getting any easier, Ecuador, well we know all about Ecuador. There is a lot of excitement about Colombia, but nothing has been permitted in Colombia yet. So it's a paradise to go and explore, but how about turning those discoveries into mines?" says Ganoza.

With their current projects up and running, both Fortuna and Rio Alto are on the hunt for their next potential mine. With both companies based in Peru it is a natural starting point, but both Ganoza and Black said they are looking quite a bit at North America for their next asset as well. Only time will tell if either company decides to leap into another Peruvian challenge or try its luck elsewhere as well.

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