Managing risks in the mining and metals sector

SUITS THE C-SUITE By Jaime F. del Rosario

Business World (10/20/2014 – p.S1/5)

THE MINING and metals sector in the Philippines is considered one of the key industries driving economic development and growth. Yet, it is also a sector that is constantly confronted with risks detrimental to the sector participants’ long-term profitability, and economic growth and sustainability. It is therefore important in strategic planning to anticipate and plan for these risks.

Many of these risks are consistent with the risks found globally, as identified in a recent Ernst & Young report titled Business Risks Facing Mining and Metals 2014-2015. These risks include:

RESOURCE NATIONALISM

Resource nationalism will remain a risk as the Philippine government looks to initiate legal and regulatory measures to increase its share from industry earnings. Early this year, the Philippines’ Mining Industry Coordinating Council approved the proposed mining revenue sharing policy which would impose either a 10% tax on gross revenue or a 55% tax on adjusted net mining revenue, plus a certain percentage of profit, whichever would result in higher revenues for the government. Additionally, a bill requiring domestic processing of all minerals extracted in the country prior to export was approved in early September at the committee stage of the House of Representatives. The bill aims to extract more value from mining.

To address this risk, mining and metals companies need to continue to dialogue with government on the impact on investment decisions of increasing levels of resource nationalism, whether in the form of taxes, use-it-or-lose it or in-country processing requirements. Companies need to continually demonstrate the benefits brought by the mining and metals industry to the broader community, and enhance the understanding that raising the cost of doing business may hinder investment and jeopardize those benefits for the country as a whole.

SHARING THE BENEFITS

Balancing competing demands from multiple stakeholders is a challenge for all mining and metals companies. Firms that fail to do so face the risks of damaging their corporate reputation, encountering project approval delays and protests or violent opposition. Companies need to ensure that these stakeholders have a common understanding of the challenges their projects face.

While there is no perfect approach that will appease all stakeholders, increased transparency helps generate trust with stakeholders. Transparency through reportorial requirements, such as the Social Development and Management Program progress reports, and participation of the Philippines in the Extractive Industries Transparency Initiative is a way to communicate how value is shared across all relevant stakeholders.

SOCIAL LICENSE TO OPERATE

Over the last few years, mining and metals companies have spent more time and resources grappling with an increasing number of groups in order to obtain or maintain their social license to operate. The risks in not obtaining acceptance from any one of these stakeholder groups can include lost potential investment streams, supply chain and customer base challenges, and reputational damage. This means that now more than ever, company leaders should take proactive measures that address the bigger industry picture. These measures should aim to develop policies beneficial to the company while also working to address the interests of the different stakeholders.

PRICE AND CURRENCY VOLATILITY

While the country’s mining output is slowly rebounding, price and currency volatility remains a significant risk to mining and metals companies. In addition, the industry is also facing much volatility in supply and demand, which means that prices cannot be expected to follow any definitive trend.

To manage this risk, companies can look at ways to enhance their flexibility to respond to these instabilities, which may include a preference for variable over fixed costs, improving their processes from more effective mine planning to increasing production efficiency, engaging in hedging, and mining high quality assets with better grades and better margins. Through such measures, the adverse impact on margins may be absorbed or be negligible.

INFRASTRUCTURE ACCESS

Since most of the untapped resources are located in remote areas, access to infrastructure is another barrier. It often falls on the company to initiate spending for developments such as roads, trails and bridges, and even social structures. While these expenditures comprise part of mine development costs, firms should view infrastructure development from a sustainability perspective, in that it provides a distinct social and economic benefit to local communities. This, in turn, helps mitigate the social license risks and visibly provides a means for companies to share the benefits of their operations with the community.

CAPITAL ALLOCATION

One of the most challenging decision-making areas in the mining business is identifying the best and most sustainable use of capital. A myriad of options are available, ranging from recycling of capital against dividend distribution, investing in and developing greenfields, acquisition of brownfields to disposal, and abandoning certain non-core projects/assets.

In one way or another, options considered by entities will likely benefit the shareholders. However, the complex part is determining how much money should be allocated to each action in order to yield the most benefit and generate as much wealth as possible to demanding investors. Mining and metals companies should zero in on the changing risk appetite of shareholders and their preferred funding mix.

CAPITAL ACCESS

Raising the capital requirement may not be the concern of large industry players but it defines survival for junior players and small-scale miners. Freestanding financiers may be reluctant to release funds to smaller mining and metals companies whose credit worthiness is uncertain. This can result in smaller companies encountering cash constraints and difficulty funding expansion projects. Consequently, cost and capital management remain essential. These companies should improve on their ability to curb high capital costs and mitigate credit risk. This includes exploring all financing options, reducing capital expenditures through incremental project design and considering strategic partnerships.

PRODUCTIVITY IMPROVEMENT

The sudden upsurge in physical commodity prices during the 2000s lured most of the mining and metals companies to focus efforts on increasing output without much regard to costs. However, when prices began falling dramatically a decade later, industry players realized that producing more does not equate to higher profitability where prices are depressed.

Mining and metals companies should embrace a significant end-to-end transformation of the whole business to deliver sustainable and long-term improvement. Strong financial performance can be achieved through productivity improvement such as reassessment of mining methods, favoring automation, and changes to overall mine plans.

Given the current issues and controversies plaguing the Philippine mining and metals industry, taking these risks into consideration may prove beneficial to our local players. In the long run, employing effective risk reduction and management exercises can help companies not only adapt to changing factors, but even thrive in this challenging environment.

Jaime F. Del Rosario is a Partner of SGV & Co.