The Lihir Gold mine in Papua New Guinea is a potent symbol of the excess of the mining investment boom that ended with the resources industry drowning in debt. Bought for A$9.5bn in 2010 by Newcrest, the Australian mining group was within four years forced to halve the mine’s value, and shed hundreds of staff to address spiralling costs.
A year after Newcrest bought Lihir, Rio Tinto spent $3.9bn on coal assets in Mozambique, which it sold three years later for $50m. Also in 2011 BHP Billiton ploughed almost $20bn into shale oil assets in the US, that are now valued at a little over half that sum.
“There was a lot of exuberance and everyone got caught up in it and that includes executives, boards, shareholders and analysts,” says Daniel Morgan, a commodities analyst at UBS. “There was a belief China’s economic boom would continue at the same fast pace.”
Lihir, one of the biggest and most remote gold mines in the world, has now become a symbol of something else: a return to profit for the mining sector. Ore production at the mine has risen by a fifth since 2014 to 13m tonnes a year after Newcrest introduced measures to boost productivity. Last year it reported record production of 900,000 ounces of gold and A$307m ($229m) in free cash flow from the mine, double the financial returns generated in 2015.
“Newcrest’s focus on boosting productivity is emblematic of a wider shift across the resources sector,” says Trent Allen, an analyst at Citigroup. “[The industry] has cut back on investment and is now focusing on generating cash and repairing balance sheets.”
It had to. At its peak in 2013 the combined net debt of the four biggest London-based miners — Anglo American, BHP Billiton, Glencore and Rio Tinto — climbed above $90bn, spooking investors and provoking a crisis that forced leadership changes at all but one of the companies, Glencore, where Ivan Glasenberg remains chief executive.
Since then the mining industry has conducted a big cost-cutting exercise, slashing capital expenditure, selling off non-core assets to raise $33bn and losing almost 200,000 jobs while boosting productivity. The results have been dramatic and, when combined with higher-than-expected commodity prices over the past 12 months, have turned the big diversified miners into cash-generating machines. BHP, Anglo, Rio and Glencore made combined profits of almost $15bn in 2016, a dramatic turnround from losses of almost $20bn a year earlier.
Big four bounce back in numbers
$20bn BHP Billiton investment in US shale oil assets in 2011
$50m Rio Tinto’s sale price for nearly $4bn worth of Mozambique coal assets
>$90bn Combined debt of Anglo American, BHP Billiton, Glencore and Rio Tinto at its peak in 2013
$15bn Combined profits of the four mining groups in 2016
For the mining groups the question now is what to do with the money? Should they ramp up expansion plans in search of growth or stick with their new conservatism by paying down debt and rewarding investors with higher dividends and shedding more assets?
“We made some acquisitions we’d probably accept were on the high side. The resource is great but we probably overpaid, specifically on the shale acquisition,” says Arnoud Balhuizen, BHP chief commercial officer. “We have learnt our lessonsin coming out of that and have a much clearer strategy.”
The Lihir mine is a vast pit dug into the side of an extinct volcano on a tiny island about a two-hour flight from Port Moresby, the capital of PNG. Viewed from the air the mine site and neighbouring gold-processing plant dwarf all other settlements on a Pacific island where many of the local people live in ramshackle wooden huts.
Miners have worked the site for 20 years, producing more than 10m ounces of gold. The mine contains one of the world’s largest gold deposits, with Newcrest estimating it has 25 years of reserves. Almost 5,000 people work at the site, which presents a series of challenges — from malaria outbreaks to geothermal activity.
Thinking differently: Craig Jetson, Newcrest’s general manager at the Lihir goldmine
When Craig Jetson took over as general manager in July 2014 the mine was in crisis and facing a community in revolt. According to Newcrest, costs were mounting following under-investment by the previous owners that led to frequent equipment breakdowns. Landowners in Lihir were demanding more money for the right to mine in the area and holding regular protests that forced Newcrest to shut the mine for days at a time at a cost of millions of dollars.
On his first visit to the mine he was surrounded by up to 150 “screaming and shouting” villagers. “Relationships were so bad that I felt unsafe,” says Mr Jetson, who moved from Zurich to live on the island with his wife. “I had police and my own team around me.”
Mr Jetson responded by appointing more local managers, reducing Lihir’s reliance on fly-in, fly-out workers, training local staff and delivering community projects and new roads, which had been promised but never completed. At the same time McKinsey consultants worked with Newcrest to identify areas where the operation was leaking cash and measures to boost productivity.
“We used data science techniques to change the way we run the processing plant and mine the ore and introduced new technology and management operating systems to boost efficiency,” says Mr Jetson.
Aerial view of the Lihir goldmine © Graham Jepson
Lihir presents specific challenges as the ore body is contained in a geothermically active area. But by using an electron microscope the team discovered the processing plant’s autoclaves — the large pressure chambers that burn off sulphur contained in the mined ore to release gold — were running inefficiently. By reprogramming them Newcrest made substantial savings, bringing the cost of producing an ounce of gold at Lihir down to $913, compared with a high of $1,328 in 2013.
Other innovations allow the Lihir management to take a bird’s-eye view of the operation, which Mr Jetson says has allowed engineers to prevent at least 200 equipment breakdowns at the processing plant. Pointing to a nearby coastline, peppered by blasts of steam and sulphur that seep out of the volcanic ground, he says Newcrest is saving another $1bn by redesigning the construction of a seawall needed to expand the mine.
“Due to the changing financial climate, we’ve had to think differently about how we do things,” he says. “The turnround is not complete . . . but we have achieved some really good results.”
The change in mindset is mirrored across the industry. Since 2013 the big miners have rationalised and simplified their operations. Glencore and Rio have raised a combined $23bn through asset sales since January 2013. BHP, the world’s biggest miner by market capitalisation, spun off a diverse range of coal, manganese, aluminium and nickel assets into a separate company, South32, in 2015 allowing it to focus on large-scale assets in iron ore, copper, coal, oil and gas.
BHP is under pressure from activist hedge fund Elliott Advisors to further simplify its global corporate structure and sell its US oil and gas business. But the miner has declined, saying it has the right portfolio of assets, strategy and capital allocation.
“The type of hedonism we saw from miners during the boom has been replaced by a sharper focus on a smaller number of core assets,” says Mathew Hodge, an analyst at Morningstar.
While financial pressure forced miners to shrink their portfolios, technology is now making them think differently about how they develop projects.
In 2012 BHP shelved a $30bn expansion of its copper and uranium mine at Olympic Dam in South Australia because of the cost and weakening commodity prices. Last year it began trials using “heap leaching technology”, a less capital-intensive mining process that involves applying chemicals to mined ore to separate metals from the crushed rock at a much lower cost than traditional mining. Rio and BHP are deploying driverless trucks at iron ore mines in the Pilbara in Western Australia. Rio is also pushing ahead with a driverless freight train network in the region, which is expected to be fully operational by the end of 2018.
BMI Research, a division of Fitch Ratings, predicts investment by the miners in technology will accelerate and that it will make lower labour costs less of a competitive advantage for emerging economies, thus boosting the attractiveness of mines in developed countries.
Monitoring rooms allow staff at Lihir to minimise equipment breakdowns
These innovations should improve the efficiency of collecting and transporting ore to ports. But they threaten to have a devastating impact on jobs and wages. The four big London-listed miners shed 191,700 jobs in the three years between June 2013 and June 2016, reducing their combined workforce to 361,000, according to their annual reports. Some of these cuts reflect the movement of staff due to asset sales, but a substantial amount is due to redundancies.
Wages at many mines have been frozen, despite demands from workers for a share of the bumper profits. A six-week strike at one of the world’s largest copper mines, the BHP-operated Escondida in Chile, is seen by some as a foretaste of further tension. Staff returned to work in March, but the failure to reach a permanent deal with BHP suggests that relations will remain fraught.
Jean-Sébastien Jacques, Rio chief executive, says he is under no illusion that cost inflation will return but warns there is no room for complacency. Rio is targeting a further $2bn worth of cuts in operating cash costs in 2017.
“The big changes in our cost and productivity agenda will continue to shape the company for the next eight to 10 years,” says Mr Jacques.
Citigroup forecasts that the big four miners will generate $167bn in operating cash flow over the next three years, which will enable management to slash debt by a further $53bn and return $35bn to shareholders in dividends. It estimates they will spend $79bn on capital expenditure. In 2012, the big four spent 140 per cent of their operating cash flows on capital expenditure.
Nevertheless, some analysts warn that if commodity prices remain high miners will find it hard to resist the temptation to loosen their purse strings and fund growth projects.
“Right now the mining industry has just gone through a world of pain and is emitting a palpable sigh of relief,” says Mr Morgan. “But roll forward 12-18 months and there is a risk the industry will begin spending again and boards will begin reacting to pressure from media, analysts or others to increase growth . . . it’s a cyclical industry.”
There are signs that high commodity prices are changing behaviour. In February Anglo American backtracked on its plan to dispose of coal and iron ore businesses in South Africa. BHP has begun investing in projects: in February it gave the go-ahead for a $2.2bn investment in BP’s Mad Dog oilfield in the Gulf of Mexico and last month won an auction to participate in another deepwater oil project in the region with Pemex, Mexico’s state-owned oil company.
“This is an excellent example of BHP being on strategy,” insists Mr Balhuizen. “The two commodities where we see growth are copper and petroleum so this is where we want to invest.” But, he insists, these investments do not suggest that miners like BHP are about to return to the profligate days of the past.
The profitability of the big diversified miners will depend on the direction of commodity prices, particularly iron ore, which generates more than half of Rio Tinto and BHP Billiton’s profits and is seen as a proxy for the health of the Chinese economy.
Prices of the reddish brown ore, the key ingredient in steelmaking, more than doubled in value in 2016 following a Chinese stimulus that reignited demand from the infrastructure, property and manufacturing sectors. But after briefly surging above $90 a tonne in March, prices have begun to slide due to nervousness over demand in China, which imports two-thirds of the world’s seaborne iron ore.
The price of the commodity fell close to $60 a tonne last week, its lowest point since November, and analysts at Deutsche expect it to settle between $50 and $60 this year due to oversupply. Even at these lower prices BHP and Rio can continue to generate healthy profits, with analysts estimating the break-even price for both at just below $30 a tonne.
Arnoud Balhuizen, BHP’s chief commercial officer, says that, within a range of $60 to $70, which is where he predicts the price will settle this year, iron ore remains a “large profit generator for our shareholders”.
Steel production in China is forecast by Rio to grow at about 1 per cent per year until the middle of the 2020s. That, says Jean-Sébastien Jacques, Rio chief executive, will guarantee demand. But, he says, doubts remain over supply with the possibility that higher-cost Chinese miners, who exited iron ore when prices slipped to $40, could now restart production.