Mining in the 21st CenturyThe Quest for Sustainable Profits

Peter Demuraαlpha εconomics

Disclaimer

The views represented in this presentation are those solely of the author and do not reflect the views of past or previous employers, clients or associates

αlpha εconomics

Today we will discuss

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• Overview of the global mining industry– Strong demand and prices shaping strategies and risk tolerances

• The investment decision– Complexity driven by more than resources

• Sustainable development need not be a zero sum game– Remains in realm of profit maximisation– Filling institutional voids

• Policy recommendations– Building governance frameworks– Trust and transparency

Why sustainable development?

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• The development of the resources a pathway to economic and political development

• Not without its costs – “resources curse”“Although leaving oil [or other resources] in the ground means that interest is forgone, the ground may just be the safest place for the asset, especially if there exists the risk that governments may use the revenue for their own purposes rather than the good of society, as has happened so often already.” Humphreys, M., Sachs, J. D. and Stiglitz (2007), What is the Problem with natural resource Wealth, in Humphreys, M., Sachs, J. D. and Stiglitz (eds.), Escaping the Resource Curse, Columbia University press New York.

• Not an option and inconsistent with the Brundtland definition of sustainable development

• Future generations benefit from the conversion of natural wealth to human and physical capital

Today we will discuss

αlpha εconomics

• Overview of the global mining industry– Strong demand and prices shaping strategies and risk tolerances

• The investment decision– Complexity driven by more than resources

• Sustainable development need not be a zero sum game– Remains in realm of profit maximisation– Filling institutional voids

• Policy recommendations– Building governance frameworks– Trust and transparency

Acceleration in world mineral and energy production

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Commodity, tonnes 1988 1998 2008 Annual growth, %pa

1988-98 1998-2008

Iron, Ferro-Alloy Metal 552,943,675 584,429,987 155,206,897 0.6 7.1

Non-Ferrous Metals 143,352,635 172,650,484 269,931,869 1.9 4.6

Precious Metals 16,742 19,585 24,031 1.6 2.1

Industrial Minerals 503,053,766 496,427,135 654,995,301 -0.1 2.8

Mineral Fuels 9,280,770,174 10,092,044,633 13,125,278,324 0.8 2.7

Total 10,480,136,992 11,345,571,824 15,205,436,422 0.8 3.0

Source: World Mining Data 2010

Australasia dominates regional production of mineral and energy commodities

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Region 1988 1998 2008 Annual growth, %pa

tonnes tonnes tonnes 1988-98 1998-2008

Europe 3,184,733,421 2,363,877,415 2,422,274,124 -2.9 0.2

Asia 3,618,769,570 4,383,349,574 7,352,040,477 1.9 5.3

Australia 339,287,866 513,335,633 769,994,315 4.2 4.1

Africa 600,753,723 795,108,264 979,356,578 2.8 2.1

South America 602,131,742 924,997,794 1,187,385,006 4.4 2.5

North America 2,134,460,670 2,364,903,146 2,494,385,923 1.0 0.5

Total 10,480,136,992 11,345,571,824 15,205,436,423 0.8 3.0

Source: World Mining Data 2010

China is a dominant supplier and user of commodities

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Commodity Country % of Total Country % of Total Country % of Total Demand % of Total

Alumina China 26.1 Australia 22.1 US 8.0

Aluminium China 33.7 Russia 9.8 Canada 8.0 China 17.3

Bauxite Australia 32.0 Brazil 14.1 China 10.8

Coal - Coking China 51.6 Australia 17.5 Russia 7.8

Coal - Steaming China 45.8 US 20.6 India 9.1

Cobalt D.R. Congo 46.8 China 9.1 Canada 5.6

Chromium South Africa 38.7 India 17.0 Kazakhstan 14.8

Copper Chile 34.6 US 8.5 Peru 8.2 China 50.1

Gold China 12.1 US 10.2 Australia 9.4Iron Ore China 23.5 Australia 19.2 Brazil 19.1 China 57.4

Lead China 39.9 Australia 16.6 US 10.6 China 35.6

Manganese South Africa 20.3 Australia 15.7 China 15.0

Nickel Russia 18.3 Canada 17.3 Australia 13.4 China 28.2

Platinum South Africa 74.8 Russia 13.5 Zimbabwe 4.9

Silver Peru 17.3 Mexico 15.2 China 13.1

Uranium Kazakhstan 20.7 Australia 20.4 Canada 18.5

Zinc China 27.5 Peru 13.8 Australia 12.7 China 35.1

Source: World Mining Data 2010, US Geological Survey, AME Mineral Economics

Industrialisation is driving demand for commodities

αlpha εconomicsSource: IISI, AME Mineral Economics

Price trends reflect industry structure and supply and demand balance

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Source: LME, Bloomberg, ABARE, Author

Global mining industry is flexing its muscles

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• Trend is for consolidation and diversification– Top fifteen companies in 1995 accounted for 30.7% of non-

fuel mine production, in 2000 it had fallen to 28.8%, by 2006 it was 38.6% and rising

– Driven by economies of scale, cost reduction, access to resources and capital markets

• The rise of the diversified miner– The top 6 miners in 2009 had a combined market

capitalization of $700 billion, 53% of top 40– BHP Billiton and Vale accounting $350 billion

Top six mining companies BHP Billiton, Vale, Rio Tinto, China Shenhua, Anglo American and Xstrata – dominate

minerals production

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Commodity Company % of Total Company % of Total Company % of Total Top Ten % of Total

Alumina Chalco 14.4 Alcoa 13.9 Rio Tinto 12.9 81.2

Aluminium Rusal 13.1 Rio Tinto 11.8 Alcoa 10.2 59.7

Internationally Traded Coking Coal BHP Billiton 10.9 Mitsubishi 8.5

Teck Resources 7.7 50.3

Coal - SteamingChina National Coal 8.7 Xstrata 7.7

China Shenhua 7.2 54.5

Copper Codelco 8.7Freeport McMoran 8.5 BHP Billiton 7.5 46.9

Iron Ore Vale 12.4 Rio Tinto 7.6 BHP Billiton 5.5 36.4

Nickel Norilsk Nickel 19.5 Vale 17.0 BHP Billiton 11.4 79.6

Uranium Areva 17.1 Cameco 15.8 Rio Tinto 15.7 89.4

Source:AME Mineral Economics, World Nuclear Association, CRU, National Mining Association.

Challenges facing the global mining industry

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• Continued access to resources • China as a competitor and geo-political response• Rise of resource nationalism and state capitalism• Capital and commodity market volatility• Pressure from NGOs and local communities

Today we will discuss

αlpha εconomics

• Overview of the global mining industry– Strong demand and prices shaping strategies and risk

tolerances• The investment decision

– Complexity driven by more than resources• Sustainable development need not be a zero sum game

– Remains in realm of profit maximisation– Filling institutional voids

• Policy recommendations– Building governance frameworks– Trust and transparency

Mining is an economic activity

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“The main purpose of mining is to satisfy basic human needs and wants and create wealth for all potential stakeholders…..Unless they can fully cover their cost of capital, and earn an acceptable rate of return, mining companies will be unable to attract sufficient funds to sustain their investment and their output. Nor will they be able to satisfy many of the wants and aspirations of the wider community Crowson, P. (2010), Mining Unearthed, Aspermont UK, London

• The presence of mineral resources does not imply their development– For decades high grade copper deposits in Sub-Sahara Africa went

undeveloped– Salient lesson to governments to ensure right frameworks in place

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Indentified Mineral Resources(In Situ)

Ore Reserves(Mineable)

Inferred

Measured

IndicatedIncreasing level of geological data, knowledge and

confidence

Probable

Proven

Consideration of economic, mining, metallurgical, marketing, legal, environmental, social, and

governmental factors

Source: Rudenno, V. (2009), “The Mining Valuation Handbook, 3rd edition, Wrightbooks, Melbourne

Only when resources become probable or proven reserves can they be developed

JORC Framework

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Moving from exploration to production is a costly, complex and prolonged process

Exploration Concept Pre-feasibility Feasibility Construction

Indicative cost and time profiles for feasibility studiesStudies Cost Time Accuracy

Scoping/Concept Studies $100,000s Months Low

Pre-feasibility $ millions Months Fair

Final/bankable feasibility and engineering design $10 millions Years Good

Construction phase Variable Years Very Good

Rudenno, V. (2009), “The Mining Valuation Handbook, 3rd edition, Wrightbooks, Melbourne

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Beyond geology and project economics is political risk

“From my own perspective, this [proposed mining tax in Australia] is my number one sovereign risk issue on a global basis,” Mr Albanese, CEO Rio Tinto

Worldwide Governance Indicators , selected countries, 2008Country Voice and

Accountability Political StabilityGovernment Effectiveness

Regulatory Quality Rule of Law

Control of Corruption

Australia 94.2 85.2 96.7 97.6 95.2 96.1Botswana 62 81.3 73.5 67.1 68.9 80.2Brazil 61.1 38.3 54.5 58 46.4 58.5Canada 95.7 83.7 97.2 95.2 95.7 95.7Chile 76.9 66 84.8 92.8 88 87China 5.8 33.5 63.5 46.4 45 41.1D. R. Congo 8.7 2.4 0.9 5.3 1.9 5.3Indonesia 44.2 15.8 47.4 45.4 28.7 31.4Kazakhstan 18.8 64.1 38.9 39.6 23.9 16.4Mexico 50.5 24.4+ 61.1 65.2 29.7 49.8Mongolia 55.3 57.9 27.5 43.5 34.9 32.4Peru 49 19.1 46.4 62.3 25.8 49.3Russia 21.6 23.9 45 31.4 19.6 15.5South Africa 67.8 41.6 75.4 71.5 56 65.2United States 86.1 68.4 92.9 93.2 91.9 91.8Zambia 45.7 54.5 29.4 41.1 38.8 36.7Each number represents the percentile rank of each country on the selected governance indicator. Percentile rank indicates the percentage of countries worldwide that rate below the selected country. Higher values indicate better governance ratings. Percentile ranks have been adjusted to account for changes over time in the set of countries covered by the governance indicators. Source: World Bank

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VenezuelaEcuador

PhilippinesZimbabwe

DRCMongolia

BoliviaHonduras

GuatemalaCaliforniaIndonesia

South AfricaIndia

ArgentinaKyrgystan

PNPPanama

WashingtonColorado

MinnesotaZambia

KazakhstanNWT

South DakotaColombia

WisconsinMontana

RussiaTanzaniaNunavut

ChinaNew Mexico

BrazilPeru

Br ColumbiaNamibia

Burkina FasoTurkeyGhana

New ZealandIdaho

NorwayVictoria

SpainMexico

MaliMichiganArizona

QueenslandTasmania

OntarioBotswana

N S WalesW Australia

AlaskaIreland

Nova ScotiaUtah

Northern Terr.WyomingSweden

YukonS Australia

ManitobaNfld & Lab

ChileSask

NevadaAlbertaFinland

N BrunswickQuebec

0 10 20 30 40 50 60 70 80 90 100

A region’s policy climate has taken on increased importance in attracting and winning investment. The [Fraser Institute] Policy Potential Index serves as a report card to governments on how attractive their policies are from the point of view of an exploration manager

A long way between the top and bottom performers

Today we will discuss

αlpha εconomics

• Overview of the global mining industry– Strong demand and prices shaping strategies and risk

tolerances• The investment decision

– Complexity driven by more than resources• Sustainable development need not be a zero sum game

– Remains in realm of profit maximisation– Filling institutional voids

• Policy recommendations– Building governance frameworks– Trust and transparency

Sustainable development need not be a zero sum game

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“sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs”

• If handled correctly, the transformation of natural capital into productive physical and human capital can propel nations forward, and meet the profit maximising objectives of shareholders

• handled incorrectly it can lay the foundation for decades of misery for countries and shareholders alike

• there is an alignment of interests between host nations and companies in ensuring sustainable development

Virtuous Cycle of Poverty Reduction

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Sustainable NationalEconomic & Political Development

Sustainable Mining CompaniesMaximising Shareholder Value

The business case for sustainable development

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Benefits of SDReputation

Brand IntegrityLower risk profileCost efficiencies

RecruitmentFinance

Licence to operateAccess to resources

Avoid regulation

Value drivers

Revenue growthOperating margins

Asset efficiencyRisk reduction

Sustainable Shareholder

Value

Deloitte (2007), A mine of information, An analysis of sustainable development reporting in the mining industry, London

The welfare case for sustainable development

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• Resource Curse is a barrier to sustainable development and successful countries have avoided the extreme forms

• Many manifestations– Dutch Disease and overvalued real exchange rate– Protectionist policies– Dependence on volatile and declining commodity prices –

deterioration in terms of trade– Over-consumption and failure to account fro resource depletion– Development of rent seeking culture prompting corruption, social

unrest and civil war• Mining, supported legislation, can kick start the

development and emergence of a diversified economy

Mining commitment to sustainable governed by sustainable development frameworks

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• The dominant frameworks are the ICMM Sustainable Development Framework and Extractive Industries Transparency Initiative

• Voluntary, but “compulsory”• Focus on reporting more than assurance

PrinciplesMeasurement

&Reporting

Assurance

ICMM Principles of Sustainable Development

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• Implement and maintain ethical business practices and sound systems of corporate governance.

• Integrate sustainable development considerations within the corporate decision-making process.

• Uphold fundamental human rights and respect cultures, customs and values in dealings with employees and others who are affected by our activities.

• Implement risk management strategies based on valid data and sound science. • Seek continual improvement of our health and safety performance • Seek continual improvement of our environmental performance • Contribute to conservation of biodiversity and integrated approaches to land use planning • Facilitate and encourage responsible product design, use, re-use, recycling and disposal of

our products • Contribute to the social, economic and institutional development of the communities in

which we operate • Implement effective and transparent engagement, communication and independently

verified reporting arrangements with our stakeholders • Source: International Council of Mining and Metals, www.icmm.org

Growing interest in the assessment of national performance to inform policy

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• ICMM Resources Endowment Initiative – toolkit for assessing impact of mining on economies

• Understanding the influence of mining on governance and institutional conditions

• Six stage process– Defining country’s economic structure– Profile of mining activities – Documenting economic and social outcomes– Understanding proximate causes of national outcomes– Assess project level impacts of mining– Assess implications of mining on governance processes

Today we will discuss

αlpha εconomics

• Overview of the global mining industry– Strong demand and prices shaping strategies and risk tolerances

• The investment decision– Complexity driven by more than resources

• Sustainable development need not be a zero sum game– Remains in realm of profit maximisation– Filling institutional voids

• Policy recommendations– Supporting private investment– Building governance frameworks– Trust and transparency

Private and public dimensions to facilitate sustainable mining

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Private Dimension• Stability and certainty• Holistic approach• Need not involve a race to

the bottom• Risk and return sharing• Balancing profit with

legitimate sovereign requirements

Public Dimension• In isolation policy addressing

individual dimensions will be ineffective

• Developing effective governance processes and institutions

• Macroeconomic frameworks• Trust and transparency

Good investments embedded in an environment of weak governance and institutions may fail to spread their benefits to the country as a whole – ICMM REI

Importance of Trust – revise ICMM Effective Governance framework ?

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A fundamental source of political decay in oil-rich countries, she [Terry Karl] argues, is the absence of productive relations between governments and their citizens; technocratic fixes are likely to have little effect absent a basic level of trust between citizens and rulers. A first step toward establishing this trust, she argues, is the provision of basic information about what monies governments receive and how it is used….. [Empirical research] suggest that the first step towards reversing the oil curse is to remove layers of secrecy that continue to surround so many aspects of the industry Humphreys, M., Sachs, J. D. and Stiglitz (2007), Future Directions for the Mangement of Natural Resources, in Humphreys, M., Sachs, J. D. and Stiglitz (eds.), Escaping the Resource Curse, Columbia University press New York.

Lack of political freedom and civil liberties will make developing trust and transparency difficult

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Better and Worst Performing Mining Jurisdictions* and Political Freedom, 2010Electoral Democracy Political Rights Civil Liberties Freedom Rank

Better Performing

Chile Yes 1 1 Free

Botswana Yes 3 2 Free

Malaysia No 4 4 Partly Free

Tunisia No 7 5 Not Free

Ghana Yes 1 2 Free

Mexico Yes 2 3 Free

Worst Performing

Bolivia Yes 3 3 Partly Free

Central African Republic No 5 5 Partly Free

DR Congo No 6 6 Not Free

Liberia Yes 3 4 Partly Free

Niger No 5 4 Partly Free

Papua New Guinea Yes 4 3 Partly Free

Philippines No 4 3 Partly Free

Sierra Leone Yes 3 3 Partly Free

Zambia Yes 4 3 Partly Free

*Based measures of economic growth and poverty alleviation, # 1-most free &-least free Sources: Freedom House(2010),Freedom in the World 2010 at www.freedomhouse.org and International Council on Metals and Mining (2006), Analytical Framework, August London

Growing interest in partnerships to fill the governance void at the local level

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is partly compensated by the emergence of new forms of global governance above and beyond the state. International organisations, civil society groups, and private business in cooperation with state agencies, or without their support, have started to voluntarily contribute expertise and resources to fill gaps in global regulation and to resolve global public goods problems. At the same time, NGOs that were once focussed on pressing governments have begun to target business firms to make them more responsive to social and environmental concerns. Scherer, A. and Palazzo, G. (2010), The New Political Role for Business In a Globalised World: A Review of a New Perspective on CSR and its Implications for the Firm, Governance and Democracy, Journal of Management Studies (Forthcoming)

To address these issues, the ICMM has recommended a series of partnerships between host governments, companies, donor agencies, NGOs civil society and communities to address poverty reduction, revenue management, regional development planning, local sourcing, social investment and compensation and dispute resolution

Good outcomes are possible

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Better Performers Worse PerformersBetter Generally Better Weak - Better (E)

Economic (S) Social Indicators

Poor Performers

Chile Colombia South Africa (E) Bolivia

Botswana Guinea Tanzania (E) Central African Republic

Malaysia Jamaica Guyana (E) Dem. Rep. Congo

Tunisia Mali Mauritania (E) Liberia

Ghana Morocco Gabon (E & S) Niger

Mexico Mozambique Peru (S) PNGNamibia Suriname (S) Philippines

Senegal Togo (S) Sierra Leone

Jordan (S) Zambia

Zimbabwe

We have come to the end

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• Industrialisation will ensure the demand for commodities

• Traditional mining areas are important but so are frontiers - but risks increased

• Industry consolidation and diversification will continue• Mining offers potential for economic development and

poverty reduction• Pitfalls are well understood but will governments

respond to ensure effective governance ?• Alternative models will fill the institutional gap.