Global Mining: New Actors, New Script?
Against the backdrop of increased societal demands being placed on mining, the author discusses some of the challenges faced by the industry, based on his keynote presentation at the PDAC 2008 Convention in Toronto
By Magnus Ericsson

Global Mine Production 2006
(% of total value of all non-fuel minerals)

Source: Raw Materials Data, Stockholm 2008.
 
During the present extended boom, not only is metal and mineral production increasing quickly but a new corporate landscape is also emerging. Established, global mining transnational corporations (TNCs) are encountering increased competition from new mining companies based in China, India, the CIS and other developing economies and from junior companies. In 2006, China became the world’s largest mining country and the so called BRIC countries— Brazil, Russia, India and China—are all among the top 11 mineral producers.

At the same time, society’s expectations of the exploration and mining industry are growing rapidly and the industry is receiving increased political attention. Barely has the industry started to come to grips with its image and environmental footprint when new issues arise. Metal and mineral supply is becoming a concern in the industrialized countries, and developing countries want a larger share of profits.

Despite cost increases for many inputs, and operating cost increases at most mines, the profitability of mineral producers has exploded. Fortune Global 500 companies in the extractive industries (including oil) reached an exceptionally high profitability in both 2005 and 2006, compared with large companies in other sectors as well as historically. The average profit measured in percent of revenues was between 25%–30% in 2006 compared with less than 20% for the pharmaceutical industry, for example; and 5% as recently as 2002.

The global mining industry faces one main challenge: To deliver sufficient volumes of metals and minerals at prices which do not fuel inflation or encourage substitution, while plowing back a reasonable share of profits into local and national host economies.

When trying to meet this challenge a few points must be kept in mind:
• Exploration and mining remain cyclical businesses. Mine output will increase and gradually catch up with demand, but in the next few years it seems likely that metal use will continue to grow at a higher pace than it did during the end of the 20th century and hence the cyclical swings will be on an upward trending curve. Metal use is solidly underpinned by both personal demand, as standards of living improve, and by infrastructure investments in countries other than China and India. The present boom has already lasted longer than any others since World War II and the “super cycle” is a fact. There is no imminent threat to the boom by the incipient recession in the United States, but the risk of indirect effects due to decreased demand for Chinese and other emerging-country exports is real.
• There is a need for a new type of international cooperation to facilitate the use of minerals as a lever for economic and social development in developing countries. This is necessary to ensure that mistakes of the past are not repeated, when an insufficient share of profits flowed back to host countries and local communities. Many countries experience largescale mining investments for the first time and their governments have no history on which to build policies. Cooperation between developing countries, between rich and poor countries, between “old” and “new” mining countries is important, as is cooperation between governments and industry.

Corporate Concentration in the Mining Industry
(% of total value of all non-fuel minerals)

Source: Raw Materials Data, Stockholm 2008.
 
Governance and transparency remain key concepts for all participants in this process. Positive experiences from countries that have successfully developed, economically and socially, based on natural resources should be systematically transferred to weak governments. The same strict demands on transparency, conduct and operational practices from reporting standards to health and safety routines should apply to all exploration and mining companies in principle regardless of origin or size. There is an important role in this fight also for the broader international community, to follow the example of the Canadian government which, for many years, has been in the lead. “Mining for Development” modeled on the successful Norwegian program called Oil for Development is but one idea presently discussed between Nordic and developing countries.

Corporate Concentration
The mining industry has been going through a consolidation phase during the last couple of years. Due to the long-term nature of exploration and mining investment the supply response has been slow, and it will take years to make up for earlier under-investment. Therefore, mining companies will continue to generate good if not record profits and mergers-andacquisitions pressure will continue at a high level. The once-fragmented structure of mining is slowly disappearing.

As mining gradually becomes more consolidated, a small number of companies control an increasing share of the global industry. This trend has both positive and negative aspects. On the one hand, the mining industry, new players included, must consolidate to create larger and stronger corporate entities. Larger companies are necessary to fund and pursue increasing volumes of R&D including expanded exploration. Skyrocketing energy, water and environmental costs must also be addressed. On the other hand, proper checks and balances must be in place to ensure that monopolistic powers are not created. The recent case of BHP Billiton making a hostile bid for Rio Tinto is one example of a situation where market domination in iron ore for the proposed new entity would be unacceptable and the seaborne iron ore market would no longer be free and competitive.

There are about 1,000 mines producing metallic ores by mechanized methods around the world, if small manual and artisanal operations are excluded. There is a huge spread between the largest and smallest mines.1 The largest 150 companies are, somewhat arbitrarily, called majors and together they represent only a few percent of the total number of companies in the sector globally. When looking at the value of the production controlled by these companies the situation is reversed; combined, they control over 80% of total global mineral production.

Number of Mining and Exploration Companies, 2006

Source: Raw Materials Data, Stockholm 2008.
 
Majors and Medium/Small Mineral Producers Globally, 2006
(% of total value of all non-fuel minerals production)

Source: Raw Materials Data, Stockholm 2008.
 
Because of the flurry of M&A activity, the industry is becoming more and more polarized. To the one side there are the large, established mining TNCs controlling a major share of global metal production, and on the other side are junior exploration companies with no current production but with “blue sky” hopes of future production. There is an absence of medium and small producers that could grow organically and become major producers over time. These companies are important in that they concentrate on smaller deposits which often have good grades but are discarded by the majors for various reasons.

Some of the most active new entrants into the top league of mining companies originate in emerging countries. But, in general, developing countries do not control their mineral production—a situation that can generate considerable problems and even politically motivated calls for nationalization. It is quite possible that there will be a backlash and nationalizations will occur again after more than 20 years of privatizations. In Russia, nationalizations have already taken place in the oil sector and a move into minerals is not far away. Another example: In early 2008, the South African mine workers union called for an increased state ownership in mining. In other countries the demand for local influence and participation in huge mining profits have resulted in re-negotiated tax regimes and new royalty programs.


Some of the emerging companies are not new to the sector but have widened their interests both around the world and into new commodities, such as Vale (formerly CVRD, acquiring nickel producer Inco) and Norilsk (acquiring gold mines in Russia and South Africa’s Gold Fields, later sold off for tactical reasons). Others are new to mining and have taken their first steps in various directions, such as:
• Making favorable deals in privatization sellouts and using these acquisitions as a steppingstone for later global expansion, such as Vedanta from India.
• Through vertical integration; a prime example being Mittal Steel, which has a clear strategy to acquire both operating captive iron ore mines and also to start new projects. Mittal has over a few years quietly bought iron ore mines in Algeria, the U.S., Mexico, Bosnia, Kazakhstan and Ukraine. The group also has a major project under way in Liberia. Russian steel companies have pursued similar strategies.
• Chinese and Indian companies transitioning from trading into production. The bid by China Minmetals for Canada’s Noranda a few years ago is a prime example of this. The pressure and support from Chinese authorities to make Chinese mining and exploration companies seek overseas for secure, stable supplies of metals and minerals certainly provides a strong incentive to do so. The imbalances between Chinese demand for metals and the role played by Chinese companies in production of minerals and metals is another reason to expect strong growth in Chinese ownership of mines and deposits outside of China in the next decade. Chinese interests taking 20% in South Africa-based Standard Bank is but one example of the growing presence of China in Africa.
• Chinese producing companies will try to secure their raw materials demand increasingly through direct investments anywhere in the world. Chalco buying 12% of Rio Tinto during the BHP Billiton takeover battle is another recent example. No doubt there will be one or several Chinese companies among the top 10 within a few years.

There will most certainly be other companies from other emerging countries following these routes.

The table below indicates how the industry would look once acquisitions proposed in 2007 have taken place. This table is based on the companies’ control of the value of mine production of nonfuel minerals in 2006 and assumes the same proportions of production in 2007 and the same relative metal price structure.


The mining industry will have undergone a remarkable transformation in just a few years time and the level of concentration has increased decisively.

Mergers and Acquisitions
A wave of mergers and acquisitions has swept the mining industry since the start of 2005 and is still going strong well into 2008. There are presently many rumors of potential new acquisitions as well as actual bids both friendly and hostile. The largest of the proposed deals is the BHP Billiton bid for Rio Tinto, which would result in the top mining company being almost twice the size of its closest competitor. The new entity would control almost 9% of the mining industry globally. A deal would probably be conditioned on a selloff of some of Rio’s assets and ultimately the company would likely control about 8% of the value of all nonfuel minerals.

The total number of mining and exploration companies in the market economies has been increasing through the entry of optimistic junior exploration companies in recent boom years and now estimated to be more than 5,000. The restructuring of the mining industry is hampered by the fact that mines cannot be moved and hence the effects on the structure of the industry by mergers and acquisitions are limited. Emerging countries have, for many years, been the primary source of new mineral production but it is only now that companies based in these countries are gradually becoming transnational giants competing with the traditional mining majors. The power and influence of these new companies will grow also in the future. Given the continued high profits of most mining companies and the favorable outlook for metal prices for the coming years—even if prices do not remain at the extreme levels of 2006–2007 the wave of mergers and acquisitions is expected to continue into 2009.

Mining Mergers and Acquisitions, 1995-2007
(Million US$ left, percent right)

Source: Raw Materials Data, Stockholm 2008.
 
Merger Mania
The year 2006’s mining M&A record—a staggering $140 billion—lasted only a year. Although the BHP Billiton/Rio Tinto deal did not materialize in 2007, last year’s figure jumped to more than $250 billion. The BHP Billiton–Rio Tinto deal alone is five times larger than any previous deal, and is surely the largest mining M&A ever. M&A activity for 2007 will be almost double the 2006 figure and more than four times higher than the second highest level, in 2001.

Mining M&A has historically been around 1%–2% of total M&A for both the number of deals made and also the market capitalization of mining relative to other industries. The global figure for 2006 has increased to almost 4% of total M&A activity, more than double the 2005 level. The mining industry has gradually increased its market capitalization with strong profits in recent years. This trend might end in 2008, as market caps sank during the first months following a general decline in share prices.

A few giant deals dominated the scene in 2007 as in 2006, but overall activity was high, with over 200 deals recorded. In addition to the proposed BHP-Rio Tinto merger, one more deal— Rio gobbling up Alcan after a protracted fight—is larger than all previous deals.

Since the mid-1990s there have been three crests of the M&A wave in the mining sector: in 1998, 2001 and the present one, lasting since 2005. The magnitude of the peaks to some degree depends on a few mega-deals that inflate the dollar value for a specific year. The Billiton BHP merger in 2001 together with the restructuring of De Beers and Anglo American in the same year were valued at $25 billion out of the total that year of $37 billion. In 1998, three deals accounting for over $11 billion made that year a record. If we look at the number of deals each year and exclude the deals below $10 million, the number is fairly constant at about 80 until the current level was reached.


Exploration Outlook
Exploration expenditure in the short term is driven mainly by metal prices and in the longer run by metals demand. The metals boom in recent years has been followed by a strong growth in exploration expenditure. Global “commercial” nonferrous exploration expenditure in 2007 is estimated to reach an all-time high for the third consecutive year at over $10 billion.2 The link between metal prices and exploration expenditure is clearly demonstrated in the accompanying table.

The exploration forecast is calculated on a model developed by Canada’s federal department of natural resources and is based on the fact that Canadian exploration is proportional to metal prices of the metals mined in Canada but lagging one year. Raw Materials Group has used the same model but applied it to global exploration expenditure. The price forecast is derived from forecasts of each metal done by leading analysts.

The figures do not include state-funded exploration spending, which is still important in many countries, notably Russia, the former CIS countries and China but also in well-established market economies such as Finland and India. In addition, spending on ferrous metals includes neither iron ore nor most of the ferro alloys, which in the present boom are estimated to between $0.5-$1 billion. Taking into account the strong growth in both Chinese and Russian exploration spending which has taken place in the last one to two years after high metal prices really made an impact through extreme import costs for ores, and including junior exploration companies with a budget of less than $3 million, total global exploration is estimated by Raw Materials Group to be $12 billion to $13 billion in 2007, reaching as much as $14 billion to $15 billion in 2008.

Commercial, Large Scale Nonferrous Exploration
(Billion US$ left, index right)

Source: Exploration budgets 1991- 2007 MEG 2008, forecasts 2008-2009 RMG 2008.
Lack of New Discoveries
(Number of discoveries left, billion US$ right)

Source: UNCTAD, 2007. 
The historical exploration figures given above are not deflated and hence in reality have not grown as quickly as indicated. Even though inflation in general has not been particularly high in recent years, cost increases for metal exploration expenditures have been much higher. There are no exact figures to measure inflation in exploration but it is probable that the cost increases seen in investment costs could be a proxy also for exploration expenditure. Suffice it to say that in some cases investment costs have risen by 50% to 100% over the last couple of years. The substantial increase in exploration expenditure over the past few years has not resulted in a proportionate rise in actual activity on the ground.

There are several structural reasons for steady growth in exploration costs apart from cost increases and staffing shortages caused by the present mining boom:
• New deposits are being found in more remote and challenging regions.
• Ore grades are continuously declining, making discoveries more difficult.
• The most easily detected orebodies— those outcropping or at shallow depths— have already been located.

Increase in demand for metals and minerals makes it necessary to actually increase the speed of discovery of new deposits if total ore reserves measured relative total metal production should not decrease. Seen in this light, it is obvious that exploration activity must be increased significantly, or at least that the coming slump—which is probable judging from declining metal prices— should not be a dramatic as the trough seen in 2001-2002 if there should not be another dramatic price peak in a couple of years.

Many new actors will enter the global mining scene during the next couple of years. Some will be new players from emerging countries starting their international “careers;” others will occur through mergers between existing mining companies. It is becoming increasingly important that the script for conduct and behavior of all mining companies, whether seasoned TNCs or newcomers, is re-written and updated to achieve three major goals:
• All companies must use the same script.
• Host countries shall receive their fair and increasing share of mining profits.
• Exploration efforts must be increased.

Magnus Ericsson is chairman and cofounder of the Raw Materials Group (www.rmg.se), an independent group of mineral economists and mineral strategy/ policy analysts based in Stockholm, Sweden.

As featured in Womp 08 Vol 4 - www.womp-int.com