Contents

Introduction: Bigger Is Not Always Better

The growth of the mining industry during the recent metals demand and price boom is undeniable. In the 2004-13 period, global copper mine production rose 24% to 18.0Mt, gold grew 21% to 3,022t, silver soared 36% to 820Moz and iron ore burgeoned 54% to 1.93Bt.

Large companies became huge via frantic consolidation and project development, and smaller firms - right down to the junior explorers - were thriving as well. Share prices and asset values soared, leading to gargantuan M&A deals backed by the logic of bulk and diversification. Individual mine operations also reached a colossal scale unthinkable 30 years ago.

The rush to bring on new capacity led to hurried studies and decision-making; escalated demand (and inflated prices) for equipment, services and skills; and the hire of inadequately qualified or inexperienced professionals to run projects and operations, at both mining and EPCM companies. Vast numbers of short term labor were employed to build capital projects which during construction didn't contribute any production.

These factors led project construction and operation costs to historic levels, in many cases far exceeding companies' original estimations. Industry-wide return on capital employed sank from 24% in 2006 to 10% in 2012. While the industry was aware that costs were rising - and often noted this as an underlying challenge - this proved secondary to the importance of growing production and headline earnings. Prices were so high that rising costs had little bearing on profitability. Indeed, productivity has always depended on price cycles, declining when prices are high and becoming a priority when prices fall.

"What [mining companies] are doing now reflects the normal conditions of the industry, which is that you can't rely on any help from the market. So, any improvement in profitability has to come from self help on cost structure," says David Humphreys, an independent mining sector consultant. "Productivity is a central piece of the puzzle in that it is one of the major drivers of cost reduction."

The unprecedented scale of operations achieved in recent years - purposely sought out in the name of economies of scale - and the speed of growth added unprecedented complexity and exacerbated productivity losses, leading miners to diseconomies of scale in just a few short years.

The growing complexity led to the build-up of silos within companies - the opposite of the standardization, end-to-end integration and best practice that companies must now apply to regain productivity.

Productivity fell 50% in Chilean mining in 2003-12, according to the nation's copper commission, Cochilco. In Australia, plummeting labor productivity in the mining sector managed to drag down the nation's total productivity, according to PwC.

Codelco's Radomiro Tomic mine in northern Chile's Antofagasta Region

Post-boom gloom

Prices for most of the main metals (at least copper, iron ore, gold and silver) peaked at bubbly highs in 2011, and as they came down the "bad habits" that had fueled the fast and furious growth were exposed. Mining company equities sank as investors lost faith. Since 2012 the industry has turned its focus back to shareholder value via cutting costs and increasing productivity, and has made some impressive headway so far.

"When you want to create value, the key is productivity," Peter Beaven, then president, copper at BHP Billiton, said in a presentation earlier this year.

But while part of the decrease in productivity was due to the nature of the cycle, another part can be attributed to lower grades, a structural problem in the mining industry. Cochilco's 2013 study of Chilean mining sector productivity showed that up to 33% of the drop can be explained by geological factors when using lower ore grades alone as a proxy for such factors. A greater portion of the drop - 48% - can be explained by geological factors when using energy consumption as a proxy, a more telling calculation because it takes into account the productivity issues associated with lower grades, such as the greater distances trucks travel around larger pits, harder ore and larger ore volumes.

Some of the productivity losses linked to lower grades may have resulted from companies electing to process this ore because they believed it might not have value in a future lower price environment, rather than from a geological lack of better grades, says Humphreys. "There isn't any real evidence available yet because there is a lag in these things, but that will tell us how reversible some of the trends of the boom years were."

The answer may depend on a mine's location. The overall grade of copper resources has fallen much further in Chile than in, say, Peru due to the maturity of its mining industry, meaning Chilean mines may have had less of a say in the matter.

In any case, efforts today to cut costs and boost productivity go far beyond targeting the highest grade ore, though this is important. Most big-ticket cost cutting has already taken place - though some processes remain pending (like more contract negotiation and divestment) - and miners are now tackling the more elusive efficiency gains through optimization.

Figure 1: Capital Effectiveness Sank During the Price Boom
[GRAFIGO:FIGURA:ID_530]

Figure 2: Productivity Development in Chile: Mining Drags Down the Total
[GRAFIGO:FIGURA:ID_526]

BUY THIS REPORT

Portada Intelligence Series

Purchase this Intelligence Series report to gain access to the full analysis.

  • Interviews with top experts in the field
  • Key challenges and trends, forward-looking analysis
  • Read the report online, or download a PDF
Go to Reports Buy now