Tracking the 2016 Trends – Part 1
25.06.2016, 15:11We are currently in an era of extreme volatility in terms of commodities, where we can experience the swiftest growth in value, and one of the sharp drops, all within a few weeks of one another.
Up to this point it has been a tale of decline, of enormous readjustment as the resources industry saw prices whip from unsustainable highs to unsustainable lows, where commodity values could no longer keep afloat many of the smaller to mid-cap players.
According to Deloitte, “mining companies are struggling to recalibrate.”
Much of this is down to the not wholly unexpected economic transition underway in China, which is turning the corner from a heavy industrial focused economy to one supporting its burgeoning middle class, which is have deep and long lasting effects on the resources industry.
However, there seems to be life returning to the industry in terms of growing demand, particularly for gold, despite dire market predictions.
The industry appears to have reached the bottom of the downturn and is slowly making its way to a more sustainable median.
Companies that emerge from this great reckoning will do so stronger and smarter than when they first entered this cycle of the industry.
Iron ore, which has ridden a short rally wave that soon receded, even drew positive forecasts, with Citibank and even Western Australia lifting their forecasts compared to early 2016 predictions.
As we move to the mid-point of 2016, we examine the apparent trends that will be defining 2016, and what way the industry will move.
Deloitte has outlined the ten trends that will affect miners. In this edition, Australian Mining examines the first five.
1. Going Lean: operational excellence
Belt tightening has been a consistent theme for the industry over the last two years.
According to Deloitte’s report a relentless focus on cutting costs has translated into enterprise level productivity improvements.
“With the downturn in commodity markets, most organisations stopped discretionary spending and improved operational efficiencies,” Deloitte Brazil’s mining leader Eduardo Raffaini said.
“But that doesn’t mean the extreme diligence can now end, it’s important for companies to consider the full range of potential scenarios – from their options to grow should the market turn, to their response strategies if prices continue to plummet.”
It stated that “whilst there is no ‘right’ solution to this quandary, industry leaders are tackling this issue in a number of ways”.
“One strategy involves a continued investment in innovation; from automation and enhanced drilling systems to data analytics and mobile technologies, companies embracing innovation are improving mining industry whilst reducing people, capital, and energy intensity.”
For a long time industry heads have said mining could learn more about productivity and efficiency by studying the manufacturing industry.
Unsurprisingly, BHP chairman Jac Nasser – a former president of automotive manufacturer Ford – advocates mining study the manufacturing industry for efficiency measures.
“Although there are as many differences between the automotive and mining sectors as there are similarities, forward thinking mining can likely make unanticipated productivity gains by taking lessons from this example – including reforming industrial relations, co-opting suppliers into the cost equation in an effort to extract efficiency, and shifting from traditional command-and-control hierarchies into a world of matrix or networked structures where human ingenuity is not overly hampered by rigid processes,” Deloitte said.
Even Rio Tinto’s former head of technology and innovation Greg Lilleyman said, “There may well be technologies from manufacturing, food processing, oil and gas or aerospace which are ripe for application [in the mining industry].”
In today’s market place, finding these operational efficiencies is more important than ever.
2. Ensuring innovation: preparing for change
Innovation is more than just a buzzword for mining; it’s an entirely new take on how they do business. They are quite literally reinventing the wheel in many cases.
“When we refer to innovation, we’re not simply referring to the next big invention, we are also encompassing incremental innovation, or a re-thinking of how we use equipment, technology or processes that we already have in place,” Austmine chair Christine Gibbs Stewart explains.
This view was supported by Deloitte, which labelled innovation as a new critical theme for miners.
“Solutions once considered unviable or inapplicable to the industry continue to be adapted to suit the needs of mining companies,” it said.
Many of these innovations centre around automated and semi-autonomous processes.
But the problem of capturing these efficiencies hinges on uptake, a problem the industry seems to have difficulty with; automation is being seen as the next step, rather than as the new normal.
“Despite this dizzying array of technologies, many miners remain at the early stage of the adoption curve – placing a majority of their innovation focus on technological optimisation of old techniques in a bid to reduce costs or discover deposits more efficiently,” Deloitte said.
“To evolve, companies need to expand their innovation focus beyond technology to also consider new ways to configure and engage externally.”
It listed a number of game changing technologies that will disrupt the mining industry. These include:
• Networks: This is the interconnectivity brought about Industrial Internet of Things (IIoT), and feeds into the Big Data movement. As machinery sensors become more prevalent miners now have greater oversight of how their equipment truly operates, giving them more flexibility in their usage and maintenance. This in turn is driving the predictive maintenance trend, which reduces the likelihood of costly, unplanned and unscheduled downtimes, instead allowing users to push get a realistic pattern of usage and the ability to predict when machinery will fail and wear rates and maintain/repair accordingly. OEMs will soon offer uptime guarantees, which will be supported by users’ in-field operational data.
• Machine learning: As automation becomes more widespread, the potential for machines to perform increasing complex tasks grow, lifting safety and productivity on site. According to Deloitte, an end game for this is the continued growth of centralised remote operating hubs, such as Rio Tinto’s Mine of the Future remote operations hub or its Processing Centre of Excellence, as well as similar remote control hubs run by Roy Hill, Fortescue, and BHP from Perth.
• Geonomics: Geonomic solutions are already seeing usage to a degree in mining, being used for in-situ mineral extraction processes as well as bio-remediation programs that use natural enzymes to clean contaminated sites through metal leaching and drainage.
• Wearables: Similar to machine sensors, but for the miners themselves. Systems like FitBit, incorporated into miners’ clothes and PPE can measure and monitor their performance and health. These are already being rolled out in terms of fatigue management systems that monitor haul truck drivers’ tiredness; heat measurement vests that monitor if workers are at risk of heat stress; and RFID systems that track workers locations on site and can be used to alert others if they face an emergency situation.
• Airships: Pegged as the potential transportation of the future, new heavy haulage designs are being developed by Lockheed Martin that can lift heavy mining trucks to remote mining locations fully assembled and ready to roll on to site the moment they land.
Australia is working to address this issue with Austmine’s inaugural Innovation Mentoring Program, sponsored by METS Ignited. This is a program for the mentoring of individuals aimed at creating the next generation of innovators (See page 6 for more). However, the next innovation wave needs to be supported by full information technology (IT) and operational technology (OT) collaboration, as well as enhanced asset management procedures, if its full impact is to be felt.
3. China’s economic transition
“If you believe that China is one of the most significant factors in the global mining market – whether it be capital, consumption, stockpiling, project construction or its announced infrastructure initiatives – then it’s imperative to pay attention to the economic and political issues shaping the country’s future,” Deloitte Canada’s global leader for mining M&A advisory, Jeremy South, stated.
Because of this China and its demand still remains at the heart of the global resources industry.
China once consumed 60 per cent of all seaborne iron ore, and despite its waning appetite it still has the largest influence on many metals due to its overwhelming demand for raw materials – relative to other nations.
However, unlike many other nations China has a highly interventionist government, which dictates market controls.
“Beyond interfering with the free movement of markets, the government’s fiscal intervention may threaten its ability to fund new programs designed to spur future growth,” Deloitte reports.
In particular, the mining industry has been keeping a close on three primary initiatives: the Asia Infrastructure Investment Bank (AIIB), created to fund a range of commodity intensive energy, transport and infrastructure projects across Asia with a capital pool starting at what the Financial Times believes is US$100 billion; the One Belt, One Road program designed to spur trade between China and its neighbouring countries along the Silk Road; and the megacity project, which aims to link Beijing, Tianjin, and Hebei into a single city of 130 million people.
Despite these transparent plans, China’s trade regime remains opaque, with Deloitte stating that “without access to transparent official data, miners remain in the unfortunate position of making forecasts based on potentially flawed information”.
The 13th five year plan released in March has given some clarity on the nation’s direction.
Some small steps have been taken in the country to address glaring oversupply issues – which many majors are now addressing by focusing on lowering output guidance – by shutting underperforming or low quality operations.
An official at China’s human resources and social security ministry said the nation’s coal and steel industries expect to cut around 1.8 million workers as it seeks to reduce capacity, and address the growing stockpiles in the country.
The latest plan to slash the country’s coal and steel workforce came only days after Chinese coal companies pushed the government to set a price floor for coal to protect against bankruptcy and stem job cuts.
The country plans to reduce around 500 million tonnes of coal production over the next three to five year, mainly by closing more than 5000 coal mines around the nation and relocating around one million workers, setting aside 30 billion yuan ($6.5 billion) to aid relocation of the workers.
China also has also announced it will not approve any new coal mines for the next three years.
These swift, if brutal, movements appear to already be paying dividends for the nation.
New data by Citigroup predicts the coal price may rise by 20 per cent on the back of these changes, as coal production falls around nine per cent, more than offsetting the predicted 3.4 per cent decline in demand.
In terms of iron ore, the rallies seen in the first half of 2016 have lifted the price out of the doldrums experienced in late 2015 to settle around the US$55 per tonne watermark, which provides a stronger foundation for continued growth in the market, although it does put the industry at risk of more marginal players returning to the sector and adding to the oversupply issue.
A national focus on copper intensive industries as part of its six strategic industries is also boosting the base metal’s future.
According to Wood Mackenzie, China’s plan to generate 15 per cent of its total GDP from industries such as IT hardware, energy storage and distribution, and new energy vehicles (which according to BHP Olympic Dam asset president Jacqui McGill uses three times as much copper as conventional vehicles) all bode well for copper.
This may drive reinvestment into its own coal and base metals industry later in the year, however most pundits believe China will focus its investment efforts outside its borders, spurred by long-term currency weakness driving them to invest in foreign assets before the yuan is further devalued and they lose purchasing power.
“This may lead to a short-term increase in outbound direct investments from Chinese state owned enterprises interested in both mining companies at the later stage of the production cycle and fixed asset investments in infrastructure that improves over time,” Deloitte said.
This has been evidenced by China’s Zijin US4298 million cash investment made in Barrick Gold’s subsidiary, and China Molybdenum’s recent spree – acquiring Anglo American’s Brazilian niobium and phosphates operations for US$1.5 billion and Freeport McMoRan’s holdings in the world’s largest copper and cobalt resource, the Tenke Fungurume mine, for US$2.65 billion in cash – only further vindicating market forecasts.
This short term resurgence is unlikely to be the new normal, with Goldman Sachs stating, “We find that the likelihood of a sustained improvement in Chinese demand during 2016-17 is low, and we remain strongly of the view that the structural bear market drives that have contributed to metals declining 20 per cent over the past year and 50 per cent over the past five years remain intact.”
However Deloitte has outlined a number of ways in which miners can prepare for upcoming incipient shifts.
One of the major methods to right the downturn is to not expect a return to double digit growth rates in China.
“Companies seeking to navigate the new normal must now plan for scenarios in which China is unable to return to its previous levels of importing and consuming commodities,” Deloitte’s report stated.
“Capital allocation, economic feasibility studies and even cost management programs will all need to be recontextualised in anticipation of more limited Chinese growth rates.”
Following from this, it encouraged miners to develop plans relative to China’s investment initiatives such as the AIIB; One Belt, One Road, and the megalopolis, playing a role in the development of these programs.
4. The new normal: What goes down must come up
Mining is a cyclical industry, what goes up must come down, and the inverse is true: mining cannot stay depressed forever.
Many in the industry are predicting the first green shoots emerging of the next wave of exploration, as well as less volatility ahead.
In fact, renewed growth in gold due to its investment safehaven status, and active steps finally taken by major iron ore producers to right the current oversupply are building upon the foundation for the next swing, regardless of reduced Chinese demand.
However, in the current period this may be brutal market economics at play rather than a full recovery.
According to Deloitte data, commodity production is still not falling as fast as economic factors should dictate, as a weaker Australian dollar and readjustment in labour costs keep marginal assets artificially buoyant.
“In other cases, majors are producing certain commodities, like iron ore, in a bid to consolidate market share,” Deloitte said.
These actions were posited by UBS analyst Daniel Morgan, who warned, “Prices can get too low, and the power of the major producers may increase too much, returning the industry to the oligopoly.”
“Other commodities with flat cost curves, like potash, may be subject to similar market plays, with Belarus’ state-owned producer Belaruskali reportedly running mines at almost full capacity and aggressively discounting prices to gain a foothold in the US and China,” Deloitte said.
“This has introduced new supply side dynamics into the mining industry, as mid-cap producers in bulk commodities are increasingly edged out of the market.”
The high costs of rehabilitation have also seen some operations keep their doors open rather than incur prohibitive site remediation costs, or even sell their operations at basement prices in an effort to divest themselves of their environmental obligations.
Motivations such as these saw Rio Tinto sell its Blair Athol mine for $1, handing over all environmental rehabilitation costs to Linc Energy as part of the deal, whilst Vale and Sumitomo carried out a similar deal, selling the Isaac Plains coal mine to Stanmore Coal for $1, with Stanmore taking on the $32 million rehabilitation obligations.
In terms of looking forward, Deloitte also pointed to the need to begin refocusing on exploration.
It noted although current oversupplies muddy the water in terms of future shortages, given the often long lead time from discovery through to production, long term thinking is required.
“Exploration is the lifeblood of a business based on finite resources; unfortunately investment in exploration remains subdued,” Deloitte stated.
“According to SNL Metals & Mining, global exploration spend declined 26 per cent in 2014, with budgets falling to US$11.4 billion, compared to a peak of US$22 billion in 2012.”
In 2015 the situation became even more dire, with many miners such as BHP and Rio Tinto looking to make quick cost savings by dramatically slashing their exploration budgets, with BHP announcing last year it saved US$142 million through cutting exploration expenditure alone.
This in turn led to a consistent decline in geoscientist and geotechnician employment levels, rising to more than 40 per cent as of the first quarter of 2016.
“Big cuts in growth capex and exploration budgets may have far-reaching consequences for miners,” Deloitte Chile’s mining leader Christopher Lyon said.
“Whilst supply adjustments make sense given current industry fundamentals and price signals, is the mining industry taking this too far?” he asked.
“If the industry does not find ways to ensure a pipeline of new deposits and think through the viability of traditional mining methods, it may find itself without a great deal of growth optionality.”
The need to position for growth becomes even starker when you consider the difficulties associated with finding high grade assets in stable regions, Deloitte said.
“Companies that don’t take the opportunity to stake early claims will find themselves competing for key reserves once markets turn, hampering their long-term prospects and profitability.”
This sentiment was echoed by Queensland Resources Council chief executive Michael Roche, who said, “Exploration is the R&D, or building blocks, for the resources sector, getting the sector ready for the inevitable future upswing.”
However, the message appears to have finally reached the major players – and Australia’s governments – as they refocus on exploration activities.
BHP has announced a renewed focus on exploration as part of its rejigged strategy.
Speaking at the Bank of America Merrill Lynch conference last month, BHP head Andrew Mackenzie outlined the miner’s focus on strengthening its assets and taking proactive action to build now for future commodity strength.
“Although we remain confident in the long term outlook for commodities, we are not waiting for prices to recover. We have everything we need in our portfolio right now to significantly increase the value of the Company,” he said.
Part of this value adding will be through increased exploration and identification of new potential assets.
“We are increasing our exploration activity to take advantage of falling costs as others pull back,” Mackenzie stated.
“We have embarked upon one of our most significant oil exploration programs, accelerating activity in our three priority basins,” he said.
“Following the positive exploration results at Shenzi North, we plan to drill a further exploration well (Caicos) in July 2016 on our nearby Green Canyon 564 lease. We will also increase the number of copper targets we test this year by 38 per cent.
“We have established a new global technology function to implement integrated programs to unlock resources and lower costs. We have opportunities identified at a number of our major assets that we expect to create significant value over time.”
This focus on exploration came only days after the Australian Government announced its intention to support resources exploration in the country, allocating more than $100 million to the industry over the next four years.
The initiative, dubbed The National Resources Development Strategy – Exploring for the Future, is a program designed to boost productivity and competiveness of the sector.
“At a challenging time for the resources sector, this important initiative will help ensure that Australia’s strength in innovation is furthered, and that we maintain our competitive edge in this world-leading sector,” national resources minister Josh Frydenberg said.
At a state level, Western Australia is also supporting future growth with the announcement of $30 million in funding from 2017 to 2020 for the Exploration Incentive Scheme.
“The support of the EIS also perfectly complements the $100 million announced in the Federal Budget last week for the Exploring for the Future initiative which enables Geoscience Australia to make available pre-competitive data for State based geological survey divisions and industry,” the Association of Mining and Exploration Companies said.
Other initiatives can also be taken to move out the slump, which is nearing its end.
By focusing on agility, and the capability of scaling production, labour and other inputs/outputs as needed; the aforementioned predictive analytics capabilities created through the innovative use of Big Data have help organisations prepare their sites for events that may shift market and operational fundamentals.
Deloitte also called on miners to work collaboratively, both in terms of partnerships and in working together to cut oversupply and right market fundamentals.
“Miners are playing a sector-wide game of chicken, wither everyone hoping someone else will blink first,” Deloitte said.
“Whilst not universally acceptable, it likely follows that companies will ease back on production in an attempt to bring balance back to the market rather than waiting to be pushed against the wall.”
5. A shift in energy demand: preparing for inevitable change
The changing face of the global energy mix, and the movement away from thermal coal as the world’s primary energy source, means miners will have to change their fundamental view of commodities.
This is being driven both by Climate Change concerns, the push to cut energy costs and reduce carbon emissions, and consumers demanding more renewable energy sources.
“Australia, like the rest of the world, is transitioning towards a lower emissions energy future. As part of this transition we are seeing a reduction in the use of coal and an increase in the use of renewables,” Australian Federal resources minister Josh Frydenberg said.
South Australians know this better than most. Just last month we saw the end of coal-fired generation in this state with Northern and Playford B power stations shutting down.”
The two largest, fastest growing coal consumers have been China and India, which in 2013 consumed 60 per cent of the world’s coal between them; however China is planning to reduce output and turn towards more sustainable energy means.
Last year the country announced plans to reduce coal consumption by 160 million tonnes, following the National People’s Congress.
China’s ongoing pollution and smog issues were the main focus of the NPC, with Chinese president Xi Jinping stating that the government will be increasing focus on the nation’s environmental standards and regulations.
“We are going to punish, with an iron hand, any violators who destroy ecology or the environment,” Xi stated.
The country also plans to supply one fifth of all its power from non-fossil fuel source by 2030.
However the Minerals Council of Australia believes that this isn't an indicator of a total dumping of coal.
"China’s evolving environmental policies are being confused with a policy shift away from coal," it has previously stated.
"Coal currently accounts for 80 per cent of China’s electricity output and all leading energy forecasting agencies analysts agree that ongoing industrialisation and urbanisation will drive robust coal demand for decades to come."
The International Energy Agency expects that coal will continue to dominate China’s energy mix to 2035, and that “China continues to import substantial amounts of coal, remaining a strong force in global coal markets”.
While China is not stepping out of coal completely, alternative power sources are making inroads into its supply mix that will dent the thermal coal market.
Part of this is turning towards gas, with China aiming to use natural gas for more than 10 per cent of its primary energy consumption by 2020.
On the back of this China and Russia have signed a US$400 billion gas supply deal.
The deal, between China’s CNPC and Russia’s Gazprom will run for 30 years and supply around one trillion cubic meters of gas.
In terms of renewables, China plans to increase its wind power capacity from 96GW to 200GW, and solar from 28GW to 100GW.
In Europe, Norway derives 98 per cent and Australia 57 per cent of their power from hydro sources.
Nuclear power is also likely to play a greater role, with France producing 77 per cent and Sweden producing 41 per cent from nuclear sources, with the World Nuclear Association expecting installed capacity to grow 60 per cent globally to 2040.
This paints a dire picture for thermal coal, which is suffering from similar oversupply and undervalue issues as iron ore, and has already driven US majors such as Peabody Energy, Alpha Natural Resources, and Arch Coal to declare bankruptcy.
According to Deutsche Bank’s supply and demand models, thermal coal is running a 30 million tonne surplus, which is predicted to rise to 68 million tonnes in 2018.
Yet, thermal coal is far from dead.
“Most major energy forecasters agree that coal will remain a critical component of the global energy mix for years to come,” Deloitte said.
The US Energy Information Administration (EIA) believes fossil fuels will continue to supply close to 80 per cent of the world’s energy through to 2040, although coal will lose market share – dropping to roughly a fifth of the global energy mix.
Despite this the overall coal consumed will rise in production levels as energy demand grows apace.
China demand alone, despite its plans to reduce coal consumption levels, is predicted to grow to close to half a billion tonnes by 2019.
When it comes to miners themselves, Australia has seen a shift towards solar power for operators whose mines are located in remote areas, with Sandfire Resources installing solar power at DeGrussa, Galaxy at Mt Cattlin, and Rio Tinto at the Weipa mine.
Lithium is also set to play a greater role in the energy production chain, and will strengthen its role as a key component in renewable energy sources (read page 12 to find out more).
The future looks uncertain, however “although forecasts for global energy demand are not assured, one thing is certain: there will always be a need for electricity,” Deloitte Argentina mining leader Edith Alvarez said.
“That means mining companies should be asking which commodities will be required across the entire power generation value chain.”
So what strategies can they implement?
Becoming more agile, and able to respond to region specific market demand will allow coal miners to maintain strength, however pure coal plays will not survive long into the future.
“As the global energy market shifts, mining companies will need to keep pace by considering the full range of market angles,” Deloitte said.
“As new technology demands expand, this will open up opportunities for commodities in related industries, including lithium and/or other metals and minerals used in battery storage, solar panels, and wind turbines.”
The increasing focus on slashing carbon emissions, and the introduction of wider ranging carbon pricing schemes means longer term strategies are needed.
“As miners develop their long term energy strategies, they will need to determine how their processes must change if carbon pricing reporting becomes mandatory rather than a voluntary disclosure.”
With these in mind miners can build a more sustainable portfolio for the next wave of mining.
This is the first half of a two part series looking at the trends that will affect the global resources industry this year. Read the July edition to see part two of the trends that will be defining your industry.
Acknowledgement
"Ore & Metals" Publishing House is thankful to Australian Mining and personally to Editor-if-Chief Cole Latimer for permission to repost this material.
