May 2009

MAC Economic Commentary

Is there light at the end of this tunnel?

By P. Stothart

Amidst the doom and gloom of present economic times, it can be difficult to find signs of optimism that could generate light at the end of the proverbial tunnel. While economic predictions can be easily contradicted, it seems evident that there are some positives emerging from the present recession and that, more importantly, mineral prices are destined to rebound in the not-too-distant future.

Sanity is returning to input costs and waiting lists

The business environment that existed until mid-2008 was one of frenzy, cost explosion and waiting lists. Companies seeking to buy mining equipment were assigned lengthy delivery times. Basics such as large tires for mining trucks carried a one-year or longer delivery lead time. As noted in 2005 by the president of a Virginia machinery company, “there are eight people trying to get the same tire.”

Capital projects that began with cost budgets in the hundreds of millions ended with budgets in the billions. Companies reported that capital investment cost projections were doubling or more during the 2005 to 2007 timeframe. The need for $16 per hour fast food workers in oil sands country was going unmet. Marine shipping costs and timelines were expanding rapidly.

These realities were the by-product of both a U.S. economic model that was amassing business debts, personal mortgages, government deficits and shady financial business practices at record levels, and the corresponding growth of Asian manufacturers supplying to this model. One benefit of the collapse of this model is that business costs and timelines are moving towards more sustainable levels. In marine shipping, for example, the Baltic Exchange Index shows that U.S. to China freight rates of $94 per tonne in early 2008 fell to $26 by the end of the year. BHP Billiton noted that the build-up of iron ore stockpiles in China that prompted suppliers to defer shipments last year is ending — causing ore shipments to rise. In one highly important Canadian business sector, the oil sands, the effect of the present slowdown is that Peter Lougheed’s vision may ultimately be realized — that an orderly, sustainable and manageable growth takes the place of the recent frenzy.

Developing countries are focusing on their own consumption

In the case of China, several million people are moving from rural to urban regions each year. To prevent potential social unrest associated with growing unemployment in its export-oriented manufacturing sector, the country is turning attention to its own internally generated growth. The potential is enormous. Consumers in the United States own 765 motor vehicles per 1,000 people, while Chinese consumers own 10. There are 20 times more personal computers per capita in Canada than in China. Chinese banks have healthy balance sheets, and the corporate and consumer sectors have low debt loads.

The $586 billion economic stimulus plan announced by the Chinese government in November reinforces the notion of the country playing a significant catalytic role on a global scale through investing in roads, housing, railways, airports, power projects and other domestic areas. A similar transition will be seen in other developing countries.

The reality emerging from the present global slowdown is that there remains a significant need for metals and minerals in China and other countries that will feed internal demand for infrastructure and consumer/industrial products.

Foreign governments are building more realistic investment environments

A by-product of the mineral price boom of the 2003–2008 years was that a number of national governments sought to dramatically increase their share of resource revenues. Ecuador cancelled concessions, suspended mining and imposed a windfall profit tax. Mongolia introduced windfall profit taxes on copper and gold. The Democratic Republic of Congo examined dozens of mining contracts in the aim of increasing the government share. Argentina imposed a tax increase on exports. Venezuela welcomed the nationalist Chavez revolution. Bolivia spoke of a desire for “nationalization without expropriation.” The governments of Uzbekistan and Russia presented numerous tax and equity control challenges to foreign investors, while the Kyrgyz government proposed new taxes and possible state consolidation.

In the present downturn, with fewer companies spending fewer global investment dollars, overly aggressive governments will find themselves with significantly reduced exploration and capital expenditures taking place in their countries. Those countries that wish to attract business investment in mineral development are choosing to move along a different path — namely, creating attractive investment regimes and enhancing the breadth and accuracy of their geological mapping databases. Smart governments are also trying to reduce permitting delays and improve regulatory efficiencies — actions that should ultimately improve the industry’s ability to respond to future demand growth.

Companies are returning to their knitting

The frenzy of recent years was reflected as well in the mergers and acquisitions activity that surrounded the mining industry. In Canada, Xstrata bought Falconbridge for $20 billion, CVRD bought Inco for a similar amount, and Rio Tinto bought Alcan for $38 billion. A possible global alignment between Rio Tinto and BHP Billiton was in discussion, valued at well over $100 billion. Worldwide, in 2006 there were 1,145 M&A deals in mining, valued at some $176 billion. Boards of directors of many leading companies were seeking aggressive acquisitions plans from senior management.

The slowdown of the past six months is causing companies to return to their knitting. While M&A activity will undoubtedly continue (there are felt to be many bargain targets for cash-rich companies, with gold companies particularly well positioned), most companies are in a mode of battening down the hatches and returning attention to their properties and assets. Increasing mine yield, improving smelting and other process efficiencies, prioritizing properties for future development as mineral prices increase — these are the types of activities that are increasing in importance for senior management. The recession is forcing companies to focus on getting their costs under control. Geology and process engineering expertise is becoming more important — M&A expertise less so.

The combination of these four factors will put the global mining industry in a much stronger position to benefit from the inevitable upswing that will become evident during the coming 12 to 18 months.


Paul Stothart
Paul Stothart is vice-president, economic affairs, at the Mining Association of Canada. He is responsible for advancing the industry’s interests regarding federal tax, trade, investment, transport and energy issues.

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