Unearthing the miners' dirty cost secrets

Miners who let expenditure soar and productivity plummet during the boom now face the awkward task of telling investors just what it'll cost to adapt to the new environment.

Last night the fall in copper and oil prices sent a shiver through most Australian mining chief executives because they harbour a deep secret which they know will adversely affect share prices when it is revealed.  

Somehow they need to tell their shareholders that substantial funds are required to improve the productivity of their mines so they can survive in the looming low-price environment.

Copper is a barometer of Chinese demand and the 3.8 per cent fall took the metal to its lowest point since the dark days of January 2012. Oil is a pointer to thermal coal prices.

This means that chief executives will be letting the secret out of the bag when prices and profits are depressed.

Institutional shareholders will not take kindly to being told that large amounts of profit or cash generation will be required to reorganise mines for a low-price environment.

These conclusions come from the remarkable PwC Australia mining productivity survey and yarning with Jock O’Callaghan, the firm’s energy, utilities and mining leader. O’Callaghan contacted me after I wrote about the difficulties facing Australia (Why the gold slide signals an Australian alert, April 16). O’Callaghan believes that more than one year’s cash generation from the mining industry is going to be required to fix what are deep problems in most parts of the mining industry. Sacking a few workers will not solve the problems. Large outlays are required and are likely to come at a time when revenues are down because of lower prices.

How on earth did this happen? In the boom mining companies invested in ways to maximise their short-term production and sell that output at what were very high prices. Sometimes they signed labour agreements that shouldn’t have been undertaken because they gave unions too much power and paid too much to workers. Other times they entered into agreements to subcontract out significant parts of their operations. Usually those subcontractors made the deal fit their own operation and were not necessarily all that productive and certainly were high-cost.

Removing these high-cost, low-productivity agreements is very difficult because long-term arrangements and large subcontractor investments are often involved. Other times miners simply structured their mines to maximise short-term output. Sometimes in minerals like the gold and copper they deliberately targeted the high-grade parts of the mine and they are now left with lower grade ore bodies, which have to be mined in a much lower priced environment.

The immediate reaction of many miners, particularly in the iron ore sector, has been simply to sack staff. That doesn’t solve the problem in the long term. It often creates gaps in their staffing and limits their ability to produce. The only way to fix the productivity problems is to undertake major changes in the way mines operate and that usually will require capital and time. PwC says to be productive, miners will have to invest in more automated mining and remote operational equipment covering entire mines plus improve logistics management and energy efficiency.

Each mine will be different, but too many maximised their output and immediate cash flow believing the goods times would last for ever. Nothing illustrates that problem better than PwC’s basic figures, which show that miners are producing 56 per cent less output per hour of work in 2012 than in 2002 and support services have ballooned from 3 to 13 per cent in that ten-year period.  

It is true that these figures have been made worse by the enormous investment in LNG which has not produced revenue, but the LNG producers have made their own set of mistakes and bloated their capital costs. This is a deep problem for Australian miners who find themselves as high-cost operators in a low-price environment.