Investing

Why the metal industry is getting harder

With demand high, miners are chasing risky new ventures—and getting embroiled in local politics.

CB_minestrike

A miner addresses fellow workers during a march in South Africa, where the mining industry has been embroiled in violence and labour unrest. (Photo: Themba Hadebe/AP)

The recent conflicts at mines in developing nations—the violence erupting in South Africa, Guatemala, Panama and elsewhere this summer—are unsettling and deplorable. Yet they illustrate the new context for mining companies around the world, which often goes unexplored in mainstream coverage.

The new reality of the global mining industry is that most of the large, high-grade mine operations located in favourable jurisdictions are getting long in the tooth. As production at these mines inevitably declines with time, mining companies are forced to look farther afield for new supply. Since all of the near surface high-grade deposits have been discovered, companies are now looking at more geologically challenging deposits, usually with lower-grade ore. Often, this means considering development opportunities in areas that are not only more complex geologically, but also carry more social and political risks.

Among other things, this explains the chronic deficit in copper supply the world has experienced over the past four years. Average copper production grades have fallen dramatically over the past decade. Simply to maintain output, companies have to process much higher tonnages in order to sustain consistent production. Increased demand from developing economies has created a supply crisis—the term is not too strong.

Producers now have to look at deposits located in jurisdictions that have no history of mining, and do not have an established mining code with its attendant regulations, expectations and guarantees. Without that legal infrastructure, companies will find it exceedingly difficult to obtain a social license to operate at the local level. That lack of support can lead to tension, and even violence.

These challenges are why the average lead time to bring a significant deposit to production has now surpassed a decade. So how should Canadian companies in extractive industries mitigate their geopolitical risk?

Hudbay uses three criteria to determine where to deploy capital and manage our risk profile. First, we focus within a fairly narrow geographic zone, in this case, investment-grade countries in the Americas. As a medium-sized producer, we have only so much management capacity to go around; jurisdictions with a poorly developed legal framework and high political risk can quite easily distract management resources away from doing what mining companies do best—building and operating mines. Second, we focus on geological settings where we feel we have particular expertise and a competitive advantage. Finally, if a project meets the first two criteria, we determine whether it can produce a return on capital. Real sustainable businesses have to generate real returns. This is particularly important in mining, where long lead times, large upfront capital commitments and resource price fluctuations can easily destroy shareholders’ capital.

Our Constancia project in Peru fits these criteria well. Peru has a deeply ingrained mining culture dating from the Inca era, and operates a sophisticated regulatory regime under which permits are granted in a timely manner to companies that demonstrate they operate responsibly and meet stringent technical and environmental standards. Peru is the second-largest producer of copper in the world, after Chile, and the third-largest producer of silver, so it definitely has mining-industry depth that we can leverage to operate efficiently. However, to highlight the challenges in bringing new copper production on quickly, consider the project’s timeline: Constancia has been almost 20 years in the making.

Senior mining companies also face the added challenge of the “scale curse”—the need to look for ever-larger deposits to maintain massive production levels. That means the necessity to take on heightened geological and political risk. If in the future we want to avoid the type of ugly confrontations we’ve seen this summer, then mining companies need to think seriously about where they do business. And with whom.

David Garofalo is the President and CEO of HudBay Minerals Inc.

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