It’s not a good time to be in mining. Commodity prices have all but collapsed. Indeed, the Bloomberg Commodity Index – a weighted measure of futures prices across a broad basket of commodities – is down nearly 30% over the past year, versus an 8.6% return for the S&P 500 index (the JSE Top 40 index is up marginally over the same period). That 30% decline might not seem like much, but the index is at levels last seen over a decade ago, at the start of this century.
Headlines daily tell a story of a global sector under severe pressure. Mine closures, exploration cutbacks, steep quarterly losses, thousands of job cuts.
In one of the authoritative reports on the sector, PwC Mine 2015, the advisory group’s global mining team noted the ‘prolonged period of low prices’ and articulated the impact of the continued cutbacks over recent years.
While this report was published in June, it largely focuses on performance and trends in 2014. If anything, declines in practically every measure have accelerated in recent months. And, given the importance of commodities and minerals to the continent, Africa and firms operating here are harder hit than most.
South Africa leads the way down, a position it surely doesn’t want to occupy. The country’s ranking in the global mining sector has been falling, with its slump in gold production rankings being most acute – it is now seventh globally, down from first just a decade ago.
PwC makes the point that ‘this year saw no companies in South Africa from the Top 40 list – the first time a company from this traditional mining heavyweight has not been part of our analysis, and a far cry from the five companies included in our 2004 first edition of Mine’.
While production has, by and large, taken a knock, it’s the obvious knock-on in terms of project funding – whether production or exploration – that will affect the sector for decades to come.
In a report published in the Africa Mining Finance Guide, Standard Bank says that ‘on balance, the funding environment has become more constrained, with fewer classical options open to companies, particularly juniors and developers, with providers of funding exercising greater discretion in making investment decisions’.
In a keynote that rattled the sector at the global showpiece Investing in African Mining Indaba in Cape Town in February, Mark Tyler, senior investment banker at Nedbank Capital said the year would be challenging for mining finance role-players across the globe, and that these are likely to be particularly felt on the African continent.
This was hardly news for the audience, however. Rather, his honesty punctured a hint of optimism among executives, after nearly five increasingly tough years.
Tyler described an ‘understandable reticence by equity fund investors to put new money into mining’, and said ‘this reluctance to invest in mining is now spilling over into most other commodities as well’.
By way of context, the 40 largest mining companies in the world lost US$156 billion, or nearly a fifth of their combined market value in 2014. While that was only half of 2013’s slide, six months into this year and the situation is even more grave.
‘There will always be an appetite, albeit a small one, for low-cost producers of all commodities – even those that appear to be largely out of favour’
A total of US$230 billion of capital was raised in 2014, according to Thomson ONE data, a 15% fall from the year prior. Equity proceeds amounted to US$27 billion, a drop of a quarter.
Given the pace and extent of share price drops nearly nine months in to 2015, issuing capital to raise funding is fast becoming undesirable and, in extreme cases, impossible for producers.
There’s no more worrying example than platinum miner Lonmin. As of August, its share price had collapsed, dropping 77% this year alone, leaving its market value at around half of its US$563 million debt facility, which matures in June 2016.
With limited ability to raise capital from the issue of equity, choices become very limited rather quickly. EY’s Business Risks in Mining and Metals 2015-2016 report states that ‘for those that can access capital, the risk of accessing capital is around the increasing complexity of the financing models’. This scarcity of capital ‘can lead to short-term responses: accept the options available – which may result in higher capital costs, loss of control and diluted future earnings potential – or risk project stagnation or even loss of ownership’.
Debt is (almost) always an option, but expensive. Analysts expect the refinancing trend to gather pace.
Asset sales are the next easiest way out but the pool of deep-pocketed, well-capitalised buyers is fast drying up (even strategic equity investments from China are becoming less common). In recent months, we’ve started to see very distressed miners dispose of assets to less distressed ones. Analysts agree that this is not sustainable.
With depressed asset prices, private equity interest has been piqued. EY says some commentators dismiss its role while others hail ‘it as the saviour of the industry’s chronic shortage of capital. The truth lies somewhere between these extremes’.
According to Standard Bank, while the ‘amount of realised investment flows from private equity into the continent has been limited to date, there appears to be strong interest from a number of such firms keen to invest in Africa’. In the report, it cites the acquisition by QKR – backed by Qatar’s sovereign wealth fund and Poland’s richest man, the late Jan Kulczyk – of AngloGold Ashanti’s Navachab gold mine in Namibia as ‘an example of the type of transaction that can be expected to flow from the private equity space in coming years’. Qatar’s is not the only sovereign wealth fund to be investigating opportunities in the sector. However the reality, says the bank, is that ‘few transactions have materialised’.
EY also makes the point that ‘depressed equity valuations, signals of price stability and the pipeline of divestments will see the deployment of funds and the potential emergence of major new industry players’.
Across the sector, the worst hit – somewhat obviously – are juniors.
PwC, rather bluntly, says: ‘Recent investor wariness of the mining sector, due to slumping prices, has caused junior financings to dry up.’
EY terms access to capital ‘a survival issue for most juniors and many mid-tier companies’. This is third on its top 10 risks facing mining and metals in 2015, beaten only by ‘switching to growth’ and ‘productivity improvement’.
According to PwC, there’s significant enough reason for concern for the ‘long-term sustainability of the industry’ because of the ‘increasing difficulty of junior miners to raise capital targeted for greenfield exploration activities’.
This isn’t only affecting juniors. Exploration spending cutbacks are cascading through the sector, right from the very largest megaminers, such as BHP Billiton, Anglo American, Rio Tinto and Glencore.
‘These reductions in capital raised and spent on exploration call into question the ability of miners to find additional low-cost reserves to remain competitive, as well as their ability to respond to eventual increases in commodity demand,’ says PwC.
‘The industry’s inertia will come at a price. If reserve levels continue to decrease, the expectation is that it may further exacerbate the demand and supply volatility witnessed in recent years.’
In its State of Mining in Africa report, Deloitte says that, according to data produced by SNL: ‘Nonferrous exploration spend for 2014 is estimated to be approximately US$1.7 billion across the continent. This is down approximately 28% from 2013 and down 50% from the peak spending year of 2012.’ Any guesses on where this number will settle for 2015?
However, while exploration spend continues to decrease, ‘the DRC continues to gain exploration spend market share’ relative to other countries on the continent.
That said, there is an inherent positive in the exploration cutbacks. The cyclicality in the mining sector is, in part, caused by this phenomenon. Exploration and production cutbacks mean a reduction in supply.
Eventually that drops to a point where demand outstrips available production. Prices adjust upwards, causing production to once more kick-start and exploration to restart. And, by definition, the cycle continues.
As Deloitte puts it, ‘the outlook for growth looks very gloomy indeed’.
However, Tyler says that despite this somewhat bleak medium-term picture, particularly for equity funding, mining finance is certainly not all doom and gloom. ‘There are most definitely still opportunities to be had, particularly for those willing to investigate less mainstream commodities, like fertilisers and diamonds, and, of course, there will always be an appetite, albeit a small one, for low-cost producers of all commodities – even those that appear to be largely out of favour.’
