Dec '10/Jan '11

Capital allocation emerges as key sector risk

Ernst & Young report notes effect of retiring and risk-averse boomers

By Peter Diekmeyer

Ernst Young report
As the mining industry recovers from spillover effects of the global economic recession, the risks that sector players face are changing. Supply side capacity issues, such as capital allocation, skills shortages and resource nationalism are heightening, while other concerns such as managing costs, maintaining a social licence to operate and climate change concerns are taking a secondary role. Those are the main conclusions reached by the professional services firm Ernst & Young in their annual assessment of key risks facing mining and metals companies.

“Capital markets are becoming more open to financing attractive projects than they once were,” said Tom Whelan, leader of Ernst & Young’s national mining practice. “However the ability to borrow remains a problem. That is forcing companies to think harder about precisely where they want to allocate their resources.”

The challenges are particularly acute for smaller projects, Whelan said. To make up for the lack of easily accessible capital, mining sector players are focusing on non-traditional strategies to build revenues. These include paying for acquisitions by issuing equity (as was done in recent deals involving Barrick, Kinross and Goldcorp), initiating joint ventures and making strategic partnerships.

Skills shortages are another long-time industry challenge that have only gotten worse with the passing of another year. “The Canadian mining sector needs to attract 100,000 new workers over the next 10 years,” said Whelan. “The average age of Canadian mine workers is the late 40s. As they retire, they will need to be replaced.”

Mining engineers are a particularly scarce resource. “Less than 1,000 mining engineers graduate each year so recruiting them is a major challenge,” Whelan added. “Even if you do hire one, you can’t just graduate them and stick them into a position of responsibility. They need to pick up experience first. With Canadian companies operating in increasing numbers of jurisdictions, the breadth of experience required is increasing.”

Resource nationalism is another issue that has come closer to the forefront. “If we had to rewrite the report today, this issue might have emerged at the top of the list,” said Whelan. “The tight economy has put a lot of pressure on governments everywhere to maximize their existing resources. Many countries are in particularly bad shape and are looking for solutions to get out of it.” These solutions range from reviewing existing agreements with mining companies to try to squeeze more money out of them, introducing new or “special” taxes, fees or levies, and sometimes near-expropriations. As a result, Whelan urges companies to take a particularly hard look before they enter new jurisdictions.

According to one long-time industry veteran, the Ernst & Young report mirrors the struggles confronting sector players. “This is an excellent list,” said Chad Williams, president and CEO of Victoria Gold, a high-growth mining sector exploration and development player. “We face a lot of the challenges included in it and the order is also reflective of what we ourselves are seeing.”

According to Williams, Victoria Gold’s main operations are in secure jurisdictions, so resource nationalism has not been a challenge for the company to date. However, both capital allocation and skills shortages have emerged as key issues. “A few of the major companies can raise $2 million or more when they need to fund major projects, but the rest are having problems,” said Williams. “The fact that boomer investors, who have in the past funded many small capitalization companies, are becoming more risk averse as they age, is exacerbating the problem.”

Williams agreed that skills shortages too will be a big problem. “One major player in our sector spent over a year looking for a CEO, but couldn’t find one with mining sector experience, so they ended up hiring someone from outside the industry,” he said. “I believe that if current trends continue, mining sector output could fall over the next 20 years due to a lack of manpower.”

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