Deloitte SA Blog

Mining companies today face challenges on several fronts when it comes to addressing supply risk effectively. There are people challenges, which include high turnover rates, a limited supply of skilled labour and service providers, and the logistics around getting personnel to mining sites in remote locations. There are process challenges throughout the mining supply chain that include: limited negotiating power in sourcing and procurement; coordination of complex global distribution networks across multiple regions and modes; a lack of upstream information necessary to perform adequate planning and forecasting; and ineffective processes to assess and quantify the magnitude of various risk types. Finally, there are technology challenges related to poor quality of data and a lack of effective analytical tools to support the modelling and evaluation of risk.

Leading practices in supply risk management address risk quantitatively and strategically, and take an integrated view of risk across the value chain and the enterprise. Strategic risks need to be segmented and separated from financial and operational risks in the current environment. Identifying the key drivers of change can help organisations prepare for changes across different time durations. Core supply chain and supply management capabilities must include an organisation, with the appropriate skills and abilities, charged with managing and reducing overall supply risk. In addition, core supply chain processes in the areas of forecasting and planning, inventory management, strategic sourcing, contract management, and supplier relationship management are a basic first line of defence to combat supply risk.

Those organisations who are more advanced in addressing supply risk deploy specialised risk management capabilities to address the more complex threats posed by regulatory and geopolitical shifts. These advanced capabilities include: focusing on market intelligence by partnering with strategic suppliers to share and evaluate data on market and economic conditions; enhancing internal systems to capture data that supports dynamic decision making; and intelligent risk modelling tools to conduct scenario analysis and optimise supply decisions.

Overall, mining companies today are faced with pressure to meet rising demand for mining commodities in a climate where the cost of supply disruptions is greater than ever. Mining companies that effectively develop the capability to manage supply risk will be better positioned to meet market demand and exceed stakeholder expectations amid volatility and uncertainty.

Download the full article . . . .  A guide to effective supply risk management in the mining industry

If you require a more information on the topic of supply risk management, the South African members of the Deloitte Global Mining Team will be more than happy to have a more detailed discussion with you. Their contact details are Werner van Antwerpen, Manager – wvanantwerpen@deloitte.co.za, Genevieve de Carcenac, Manager – gdecarcenac@deloitte.co.za and Tomek Jekot, Senior Manager – tjekot@deloitte.co.za.

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If you require a more detailed discussion with our mining leaders, contact the Deloitte South Africa Mining Leader,  Tony Zoghby, at +27 (0)11 806 5130 or tzoghby@deloitte.co.za and the Deloitte South Africa Mining Advisory Leader, Abrie Olivier, at +27 (0)82 874 6040 or aolivier@deloitte.co.za

Investing in African Mining Indaba Insomnia Index Findings

Delegates at the Investing in African Mining Indaba 2012 had the unique opportunity to participate in the Deloitte Insomnia Ondex. The fourteen themes selected had specific emphasis on challenges and opportunities mining companies could face when expanding their business into Africa. The Mining Indaba Insomnia Index results show that the top four opportunities mining professionals see in Africa are Exploration, Emerging Markets, Mergers & Acquisitions and Technology. The top four challenges identified by the Indaba delegates are: Infrastructure, Price volatility, Skills and Reporting & Compliance.

Mining the Detail

Opportunities

1. Africa is home to the majority of the world’s mineral wealth and is therefore seen as a huge opportunity for mines and making exploration top of the opportunity list. Many parts of Africa are seen as an untapped market and therefore a potential growth opportunity.
2. The expected demand from emerging markets for minerals could be seen as an offset to some of the risk that entering a new market brings. Africa’s relatively central location to emerging markets can be seen as a benefit from a supply chain perspective, both inbound and outbound.
3. The major players in mining are typically target acquisition of developed assets and possibly see acquisitions of existing mid-tier mines operating in Africa as a faster growth and penetration strategy. Mergers & Acquisitions could overcome the lack of skills, local knowledge, goodwill and technology that mines could encounter when expanding into Africa. The consolidation of the mid-tier market specifically in South Africa could be another influencer for delegates seeing Mergers & Acquisitions as a big opportunity.
4. Technology is an enabler for mines to mine deeper, assist with health and safety analytics and practices, employee training and to optimise operating efficiencies to name a few. It is therefore no surprise that miners see technology as an opportunity when considering expanding their business into Africa.

Challenges

1. The impact on operating efficiency due to lack of infrastructure in Africa is seen as a massive challenge for mines. The lack of rail and road, as well as power and water in large parts of Africa make it incredibly difficult for companies to start operations in Africa. Mines need to consider the extra funding and potential partnerships with local governments in order to operate in Africa.
2. Price volatility is a global challenge and so it is not a surprise that executives see this as a challenge when considering doing business in Africa. The large fluctuations could impact significantly on profitability, cash flow and input costs which ultimately negatively impact the investment case.
3. The respondents listed skills as a main challenge when considering doing business in Africa. Mid-tier miners who are not afforded the same access to a global network of skills that the large-scale miners have, may see this as more of a challenge as the cost of importing skills to remote areas in Africa can be very high. Attracting skills into remote locations continues to be a problem mines face as well as making careers in the mining industry attractive to Generation Y.
4. Reporting and compliance in the different countries in Africa can be difficult to navigate without local knowledge and understanding of the specific requirements. Respondents listed this as the fourth biggest challenge when looking to expand their operations into Africa.

Summary

Africa clearly has many growth opportunities for the mining industry. The questions now are how do mines overcome the major lack of infrastructure, skills and local knowledge in order to leverage off these opportunities? And will the demand from emerging markets continue to grow and will mines in Africa be able to supply this demand in time in the most cost efficient manner?

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by Dr Jacek Guzek, Director at Deloitte Consulting

For more information or a detaled discussion on the subject, contact Abrie Olivier (Mining Industry Leader) at aolivier@deloitte.co.za  or +27 (0)82 874 6040 and Jacek Guzek (Associate Director) at jguzek@deloitte.co.za or +27 (0)82 940 6896.

Who actually benefits from mining?

Although the tide of resource nationalism has risen globally, with countries from Africa to Australia, Brazil, Canada, Chile and India considering options to increase state interventions in the mining sector, nowhere is the debate as high-profile, emotionally charged, divisive and potentially damaging as in South Africa.

The country is admittedly sitting on a mineral treasure trove second to none: 52 commodities reside under its surface, including the world’s largest reserves of platinum, manganese, chrome, vanadium and gold, and major reserves of coal, iron ore, zirconium and titanium minerals – all at an estimated in-situ value of $2,5 trillion¹. It is evident that the South African mining and minerals sector has immense value generation potential.

But in spite of its mineral (and other) riches, the country has been criticised for being seemingly slow in addressing what Mineral Resources Minister, Susan Shabangu, called South Africa’s “evil triplets”, namely: poverty, inequality and unemployment. Against this context, the proponents of a radical state intervention into the South African mining industry assert that the mineral wealth of the country ends up in the pockets of “monopoly capital” rather than benefiting its population at large. Who actually benefits from mining, they ask, and is it at the expense of those who truly should be benefitting? Let’s examine the question simply from the high-level value creation (or destruction) point of view.

Each (not only) mining opportunity has an inherent, or “in-situ”, value, which could eventually end up in the pockets of enterprising investors, if not for various concessions necessary to convert it into a commercial value all along the life-cycle of the project. These concessions, at a very high level, could include: R&D capital, investment capital, operating costs (including salaries of employees and procurement from suppliers), time value of money, royalties and taxes, etc. (refer to figure 1 below).

In the end, only a small residual portion of the inherent value of an opportunity finds its way to original private shareholders. In our experience, there are many successful mining projects where this residual value is only a lower single-digit percentage of the primary in-situ value. The remainder, in fact the lion share of the inherent value of any commercial opportunity, ends up in the economy at large, either through state treasury or through private sector spending, where it benefits all and translates into wealth and jobs.

Citigroup Global Markets² estimates that “only 7% of the value generated by SA miners gets distributed to shareholders i.e. the entrepreneur and risk taker. The biggest beneficiaries are in fact suppliers to the industry, mining sector employees and the government. To turn opportunity into this value (and many fail along the way) requires substantial upfront investment capital and specialised and scarce skills.

Figure 1: In-situ value graph

The question remains, why would government want to assume full risk of a complex entrepreneurial activity for such an incremental value, given the significant investment requirement?

In spite of some notable exceptions, governments’ track record in managing commercial entities the world over is, at best, inconsistent³. One can therefore question what value will ultimately accrue to society by replacing the role of the entrepreneur with a government institution. Transferring ownership from private shareholders to the state, to ensure “fair” distribution of generated value, creates a different set of incentives for public sector entities, potentially resulting in consequences contradictory to the primary intentions. While maximising shareholder value is what drives the management of private companies, the definition of objectives for a state principal is a lot more complex and politically charged. Alternatives such as financial sustainability, job creation, fair distribution, or community development often require trade-offs between efficiency and policy imperatives, blurring the overall mandate. In addition, performance of managers in the public sector companies is not always subject to the same level of scrutiny as is standard in the private sector. Furthermore, public firms do not face take-overs or bankruptcy, with all their threatening but performance-enforcing consequences.

On the other hand, for a relatively small reward or incentive, private investors shoulder the entire burden of risk in developing and managing complex opportunities. They are also usually willing to wait for returns throughout volatile economic and commodity
cycles. But any entrepreneur has to be assured that this risk is worth taking, considering the alternatives to deploy their capital in the most productive manner, and the security of tenure is the very basic consideration.

It therefore appears that the intensity and profile of the debate on nationalising the mining industry in South Africa is far out of proportion with respect to the actual value that its resolution is capable of generating or redistributing.

Rhodes University economists, Gavin Keeton and Greg White, estimated in 20104 that had the nationalization of the South African mining industry been carried out then, the bill to the government would be around R850bn (i.e. the market value of listed SA mines).

If the government were to borrow this sum at the current interest rates, annual interest payments would amount to R72bn, almost 8% of total state spending. Even if state ownership had been limited to 51% and nationalisation without compensation was considered, the interest payments would still be close to R20bn, as foreign owners of SA mining assets would have to be compensated based on international and

bilateral investment treaties. In return, the government would gain some R20bn of extra after-tax profits of nationalised companies belonging to the state. Claims that nationalisation will enhance the state’s “fiscal capacity” are therefore false.

“It therefore appears that the intensity and profile of the debate on nationalising the mining industry in South Africa is far out of proportion with respect to the actual value that its resolution is capable of generating or redistributing”

Historically, metals and mineral resources seem to have been the favourite nationalisation targets – especially at the peak of commodity cycles when windfall profits have been evident. Only the banking sector can be said to have been targeted for nationalisation with similar resolve. What is conveniently forgotten is that the global mining industry goes through alternating cycles of poor- and super-profitability, and a steady stream of positive free cash flows is not guaranteed.

The South African mining industry, although neither the biggest contributor to domestic product nor the largest employer, cannot be underestimated in terms of its importance to national economy or, indeed, to national identity. It is only natural that a society with the South African level of inequality, debates the best use of its resources. However, the focus of such a debate should rather
shift from re-distribution of relatively insignificant residual value to identifying and removing impediments to growth of the mining industry, which has the potential to generate far greater wealth than is presently the case. More so, considering that efficiency, diversity, and the competitiveness of the mining sector are not questionable.

In the words of the State President, Jacob Zuma: “The state prepares the environment for economic growth and provides support to the private sector by providing enablers and removing obstacles” (a speech prepared for delivery at the World Economic Forum in Davos, Switzerland, January 2012). In such an environment both the state and the private mining sector have at their disposal multiple instruments and tools to optimize components of the industry value graph, which can forward the developmental agenda of the government as well as accommodate just rewards for entrepreneurial risk. Exactly who benefits from mining is as important a question as who would lose on its nationalisation.

For more information, please contact Abrie Olivier (Mining Industry Leader) at aolivier@deloitte.co.za  or +27 (0)82 874 6040 and Jacek Guzek (Associate Director) at jguzek@deloitte.co.za or +27 (0)82 940 6896

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1. Chamber of Mines, Facts & Figures 2010

2. Nationalisation – killing the goose that lays golden eggs, 29 June 2011

3.“The return of state-owned enterprise: should we be afraid?”, A. Musacchio and F Flores-Macias, Harvard International Review, 31/07/2009

4. Nationalising the mines will be an expensive business, Business Day, 20/09/2010