Above-ground risk: time for mining to get serious about performance
With supply pressures forcing mining companies to operate in ever-challenging environments, above-ground risk needs to be mitigated.
Author: Ben Cattaneo, (ERM Ltd)
Posted: Tuesday , 25 Aug 2009
LONDON -
mineweb.com
Whether it is coups in West Africa, contract reviews in the DRC, community opposition to mining projects in Alaska or Canada, or NGO campaigns in Latin America, the mining industry remains incredibly exposed to "above-ground risks": politically, socially and environmentally-caused project delays and cost overruns (above-ground risk is also sometimes called "non-technical risk"). While the global recession has many mining companies focused on reducing debt, controlling costs, cutting capex and exploration spending, or divesting assets, many firms ought to look to an additional way of enhancing value: improving their above-ground risk performance.
In the current climate, mining companies are even more sensitive and vulnerable to costly project delays stemming from above-ground risk. They are also facing increased competitive pressures from companies from emerging markets, particularly China. On top of it all, current approaches need an overhaul.
In spite of the use of political risk insurance, government lobbying to reduce political interference, the existence of CSR departments, a proliferation of internal training programmes and sustainability reports, current approaches are inadequate. Many of these activities often treat above-ground risk as peripheral to the business, and many more only create marginal commercial value. This needs to change.
This is because of three fundamental realities:
1) Supply and demand dynamics will continue to force mining companies to pursue resources in challenging environments - both in the developed and the developing world;
2) This is complicated by competition from new players - particularly Chinese and Russian companies - who don't play by the same "rules";
3) Current approaches are predominantly compliance-driven and peripheral to core business activities.
Supply and Demand Still Counts
Commodity production is of course a long-term endeavour. An examination of the fundamentals tells us that demand for metals will remain robust over the long-term while supply is constrained. This is going to keep exposure to above-ground risk high as mining companies are forced to pursue opportunities that are politically and socially difficult.
On the demand side, China remains a key driver. China is spending considerable resources stimulating its economy in order to keep growth levels high. Much of this spending is focused on infrastructure where its needs are particularly acute (see Exhibit 1). As a result, demand for industrial metals will remain high in the medium term.
In addition, in both China and India, demand for automobiles will likely increase - driven by the increasing size of the middle class in both countries (see Exhibit 2). Moreover, if efforts to address global economic imbalances involve reducing household savings rates in China to increase consumption, then demand for all types of consumer goods will increase, further stimulating demand for iron ore, copper, aluminium and so on.
While demand is likely to remain robust, supply of many industrial metals will remain constrained over the longer term. Investment in exploration and production capacity remains limited and for many firms, future growth will come from politically and socially unstable parts of the world. Indeed, some of the world's largest ore deposits are found in the likes of the DR Congo, Guinea, Pakistan, Mongolia, and Afghanistan, to name a few (see Exhibit 3). Many of these countries are characterised by political instability, weak rule of law, social problems and poor governance.
Of course, above-ground risk is not limited to the world's least developed and supposedly riskiest countries - ask anyone trying to develop resources in Alaska or dealing with native land claims in Canada.
Above-ground risk is already a significant source of project delays. In fact, if recent ERM research on oil and gas projects is anything to go by, above-ground risk is the most prominent cause of major project delays in the extractive industries (see Exhibit 4).
It is clear that above-ground risk is a key commercial issue. Companies that ignore it will find themselves running into project delays and overtaken in increasingly crowded playing field.
The New Politics of Natural Resources
Western companies will have to continue to deal with above-ground risk in an increasingly competitive environment. It is clear that Western companies face new and increased competition from companies from emerging market economies and this reality will not be eradicated by the economic downturn. At present, 40% (4/10) of the world's largest mining companies come from the BRICs (Brazil, China, India, Russia). China in particular will continue to seek resources directly from the source - either by obtaining mining concessions or by trying to take stakes in producing companies - the now-scuppered Chinalco-Rio Tinto deal being a case in point.
Non-Western extractive companies do not all compete on the same terms, or with the same objectives as most large Western companies. This makes managing above-ground risk even more difficult. Some of the key differences are:
Resources more important than profits - Particularly in the case of Chinese companies, the priority has been to secure access to resources rather than the creation of shareholder profits. This creates competitive pressures at a time when lower commodity prices, reduced cash flows and higher capital costs are squeezing available investment capital and eroding net present value (NPV) across all projects.
Political backing - Western firms are going to have to continue to compete for resources against non-Western firms who will continue to enter new markets on the back of soft loans and infrastructure agreements between their home and host country governments. Many of these deals have led directly or indirectly to mineral concessions. The increased role of China in Africa has been much discussed in this regard. China is now applying this model in Latin America where it is providing loans to the state and state companies in Brazil, Argentina, and Ecuador. This type of backing is something Western firms no longer enjoy.
Less adherence to Western concepts of governance, social and environmental performance - Non-Western firms do not adhere to the same practices as Western firms on a range of "sustainability" issues. This is not to say they don't obey local laws. However, one will not see a Chinese or Russian firm engaging in practices beyond what is required by local laws because they do not face the same shareholder and stakeholder pressures as Western firms (see Exhibit 5 as an indicator of this).
Above-Ground Management: Compliance-driven, Performance Shy
Current approaches to deal with above-ground risk are inadequate in the face of modern challenges. Above-ground risk is volatile, cuts across a number of areas and affects core business objects. Common approaches tend to be static, "siloed," and designed for compliance purposes. Below is a typology of some common failures:
Technical culture - Often, a technically-oriented corporate culture leads to many firms downplaying the importance of above-ground risk on projects and to the predominance of a "below-ground" bias. There are many instances of technical solutions applied to non-technical problems - usually this means an emphasis on processes and systems rather than accountabilities, incentives, strategy and leadership.
Alphabet Soup - Often, internal resources dedicated to dealing with above-ground risk confuse their internal stakeholders with a bewildering array of acronyms and jargon.
Compliance focus and inadequate targets - Targets on above-ground issues often are compliance-based or fuzzy (e.g. focused on securing permits or otherwise not measurable) rather than commercial (e.g. avoiding project delays or cost overruns).
Misaligned incentives and unclear accountability - Manager incentives are frequently at odds with actions that maximise the business value of above-ground performance (e.g. incentives that prioritise short-term production targets at the expense of managing above-ground issues that later lead to reduced production). Similarly, accountabilities for above-ground risk are often unclear, making it safer for these issues to be side-stepped rather than actively managed.
What Needs to be Done
We believe that mining companies need to do the following in order to improve above-ground performance:
Understand, assess, and quantify above-ground risk realistically, and in commercial terms - Companies should spend more time understanding the nature of, and their exposure to, above-ground risk. This should involve robust quantification and an understanding of how above-ground risk can affect production forecasts, project schedules and capital expenditure. Quite simply, what gets measured gets managed.
Emphasise practical support - Companies need to deploy the resources they have on above-ground risk intelligently. This means providing practical, on-the-ground support and minimising corporate HQ-led activities.
Integrate project teams - Technical, commercial and above-ground specialists need to all be involved in project planning, decision-making, and execution as a part of cross-functional teams.
Align incentives - Companies need to align incentives so that above-ground, technical and commercial incentives are designed to deliver realistic commercial targets.
Provide strong leadership - Company leadership must have a high degree of visibility of the above-ground performance of the firm and be involved in driving the shift from a compliance to a performance-based approach.
Make accountabilities clear - Companies need to assign clear accountability for all aspects of above-ground performance.
Measure results with core business metrics - Value on above-ground performance needs to be measured using the same type of metrics as those used in the rest of the business - project delivery, cost and capex targets and share price performance.
Many will be familiar with these points. The challenge is making them happen and the stakes are high and getting higher. Those who succeed in doing so will position themselves to deliver sustainable shareholder value in the years to come.
This article is a shorter version of a longer report - "The New Politics of Natural Resources." The full report can be downloaded at above-groundrisk.com )
Ben Cattaneo specialises in helping companies develop and implement strategies to manage above-ground risk, particularly in emerging markets.
ERM is the world's largest sustainable development consultancy. It helps organisations understand and derive value from environmental and social performance. See www.erm.com. |
