“Top business risks in the mining industry” by Jaime F. Del Rosario (November 1, 2010)

SUITS THE C-SUITE By Jaime F. Del Rosario
Business World (11/01/2010)

Mining is an industry known to be fraught with risks. Mining companies that have succeeded both globally and in the Philippines are those that are able to truly anticipate and effectively manage such risks inherent in the industry.

These risks were highlighted in the Ernst & Young Business Risk Report 2010, which was produced after extensive consultation with top executives from the industry.

Capital allocation

The recent global financial crisis had companies shifting to equity financing to raise much-needed capital, unlike during pre-crisis conditions when companies were highly-leveraged. Today, available funds obtained through equity are being used for working capital requirements and balance sheet treatment, rather than financing acquisitions.

As mining companies become increasingly conservative post-crisis, projects with low rates of return but with growing risks have become less appealing to investors. Decision-makers are now more focused on cash flow, forcing the question of whether to use available cash to pursue expansions, to return as shareholder dividends, or to make high-priced acquisitions.

Skills shortage

Mining companies have started refocusing on recruitment, but are confronted with a lack of available skilled manpower. This is a situation that can greatly affect the Philippines, especially since projections anticipate a manpower shortfall in mineral-rich countries such as Australia and Canada within seven to 10 years. It is likely that these countries will begin competing aggressively with the local mining industry for Filipino talent who are lured by overseas work opportunities.

Cost management

Another significant challenge for companies is how to effectively contain costs, with input costs now building up due to the recovering global economy. Prices of steel and oil are increasing, as well as transport, labor and power costs.

When companies are not able to manage their costs effectively, their long-term growth potential may become limited, shareholder value may decrease, assets may ultimately be impaired, and the risk of fraud may increase.

Resource nationalism

Mining bounced back with relative ease from the aftermath of the crisis. However, because of this, governments are now reassessing the fiscal terms of economic rent for projects within their countries as a means of compensating for other fiscal losses.

Resource nationalism may mean that: (1) resource rent will be imposed on a project; (2) royalty rates paid to governments will be increased; (3) stricter controls on foreign participation will be enforced; (4) state exploitation of resources will be favored; (5) “use it or lose it” demands are imposed; (6) mining laws will be changed to increase governments’ share; and (7) taxing exports to direct these outputs to the development of local industries instead.

Through the Mines and Geosciences Bureau, the Department of Environment and Natural Resources (DENR) has initiated the review of idle mining claims and tenements that can be “re-owned” by government and reallocated to investors willing to pursue the projects. Another DENR initiative aims to declare more mineral reservations in the country that will earn for the government an additional 5% royalty on mining operations held in such mining reservations.

Maintaining a social license to operate

Mining companies must work as part of the society and host community where they operate, and be accepted as a significant player in the country’s social development. Without a harmonious relationship with the community, the social license to operate is lost, and companies will not have access to the community’s resources. To address this, companies should be well aware of changes in legislation or regimes and manage a range of issues affecting compliance.

Revised legislation with regard to the Social Development and Management Program (SDMP) provides that mining companies are now required to annually allot 1.5% of total operating costs for SDMP purposes. Compared with the previous allotment of 1% of direct and milling costs, this will certainly increase the SDMP costs of companies. Mining companies are poised to face opposition if they fail to comply with the revised SDMP provisions.

Moreover, the Chamber of Mines of the Philippines recently issued a guidebook on Corporate Social Responsibility in an effort to help companies practice responsible mining.

Infrastructure access

Access to infrastructure is key to a mining company’s ability to capitalize easily on a recovery. However, infrastructure is, more often than not, lacking in the Philippines. This results in mining companies owning the needed infrastructure to maximize their earnings. This may not be an optimal solution, since combining a high risk/return business such as mining, with a low risk/return business like infrastructure may contribute to a lower enterprise value.

Access to secure energy

Since mining companies are highly reliant on energy for product extraction, they need access to affordable energy. In the Philippines, where a power shortage looms and prices have been increasing, some companies have begun investing heavily in power stations at their project sites to avoid power interruptions and to curb costs. Companies without available capital may be forced to temporarily suspend operations during times when power prices are prohibitive.

Access to capital

Mining companies are very dependent on having access to the capital markets. Before the crisis, projects, exploration activities and cash flow needs were mainly funded through debt.

Now, many companies find it hard to renegotiate their terms of payment and some have been forced to sell shareholdings to satisfy their obligations. This led to a shift in funding through equity. We believe that in the near future, companies will gravitate towards initial public offerings, more investors will take on projects, spinouts will be more common and floating of individual mines will return.

The risks indicated above will vary and shift as the world economy recovers and renews itself. For the mining industry to remain successful and competitive, it is vital that companies focus on effective risk management that covers the many social, economic and political factors confronting them today.

(As of publication, Jaime F. Del Rosario is an Assurance Partner of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.