Gold ore mining All that glitters is not gold November 2013 Publication No. 13-04 Contents 1 Overview 2 Gold price 3 Cost accounting 4 Cost structure 5 Outlook Australia has the world’s largest gold reserves and is the second largest producer (after China). The industry has total revenue of $15.2 billion and profit of $3.5 billion and expanded rapidly as a result of the counter cyclical gold price escalation following the GFC. The price of gold tends to be counter-cyclical to general economic conditions and increased investor demand following the GFC led to a gold price increase of 12.9% per annum over the past five years. This, in turn, drove industry production and revenue to new highs. Cash costs form the foundation of mining performance measurement. However, disclosures have tended to underestimate the true costs of mining and selling an ounce of gold. New standards recently introduced by the World Gold Council will provide greater transparency but also materially increase reported costs. The ‘goldilocks’ era of ever increasing gold prices is likely over and the industry must achieve higher productivity growth to avoid contracting profitability and mine closures. Whilst miners are firmly focused on cost savings, the challenge ahead is significant. Investors expect gold miners to deliver returns leveraged to the gold price. These expectations have not been met and a paradigm shift is required to regain investor confidence and build sustainable production against a backdrop of lower gold prices. 1 Overview Australia has the world’s largest gold reserves and is the second largest producer (after China). The industry has total revenue of $15.2 billion and profit of $3.5 billion and expanded rapidly as a result of the counter cyclical gold price escalation following the GFC. The gold mining industry has undergone a revival over the past five years, with an annual average growth rate of 11% being driven by an escalating gold price. Australia’s gold mining industry has total revenue of $15.2 billion and profit of $3.5 billion. The industry expanded rapidly as a result of the counter cyclical gold price escalation following the GFC. $15.2 billion Revenue Gold is Australia’s third largest export (after iron ore and coal). Australia has the world’s largest reserves and is the second largest producer (after China). $3.5 billion Profit 11.0% The demand for gold, whether in ingot form or fabricated into jewellery or coins, is primarily driven by its role as a store of wealth. Industrial uses for gold are very limited. Annual growth (FY08-13) 6.8% The majority of gold in Australia is mined through open-cut production. This involves earthmoving equipment removing waste rock (overburden) to uncover gold bearing ore. Annual growth (FY13-18) 265.0 Underground mining is used when the ore is located some distance below the surface. Underground mines may be standalone or, sometimes, they are developed beneath worked-out open-cut mines to recover ore that was uneconomical to recover through overburden removal. Gold mine output (tonnes) Source: IBIS Research Major markets Electronics 7.3% Dentistry 1.0% 4 Other 2.0% Gold reserves Reserves Official reserves 11.7% Reserves 0 Jewellery 42.5% 2012 Production 2,000 4,000 6,000 8,000 100 200 300 400 China Australia Investment 35.5% United States Russia Source: Australian Bureau of Statistics South Africa Gold mining production in Australia Underground 20% Peru Canada Indonesia Open-cut 80% Uzbekistan Production 0 Source: US Geological Survey, January 2013 Source: IBIS Research Geographical spread 5 The bulk of Australia’s gold ore is mined in Western Australia, reflecting the geographic location of the lowest cost gold ore resources. Gold mining activity heat map Hot Warm Neutral Cool Cold Percentage of national gold ore mining revenue Percentage of national population Northern Territory 5% 1% Queensland 6% 20% Western Australia 70% 10% South Australia 4% 7% New South Wales 11% 33% Victoria 2% 26% Tasmania 2% 3% Industry players 6 The industry has a moderate level of concentration, with the top four miners accounting for nearly 60% of the overall industry. There are approximately 200 other participants in the industry, but they are much smaller in size. Newcrest Mining 24.5% Newmont 15.5% Barrick Goldfields 11.1% 6.8% Source: IBIS Research The four largest participants are all global participants with substantial offshore mining interests. The next largest player, Evolution Mining, only accounts for 4.3% of the industry. The large number of smaller operators are typically engaged in exploration or small scale extraction and are often acquired by larger players once viable ore deposits are identified. Other 42.1% Evolution Mining 4.3% Concentration levels are increasing through merger and acquisition activity. The smaller players tend to lack the financial capacity to support the substantial capital investment required to undertake commercial extraction and are unable to achieve the economies of scale that larger players enjoy. 2 Gold price The price of gold tends to be counter-cyclical to general economic conditions and increased investor demand following the GFC led to a gold price increase of 12.9% per annum over the past five years. This, in turn, drove industry production and revenue to new highs. Given a relatively fixed cost base, the fortunes of the industry are largely tied to the rise and fall of global gold prices. The price of gold tends to be counter-cyclical to general economic conditions. As a store of value and ‘safe haven’ from risk, the demand (and price) of gold tends to increase during times of economic uncertainty. Likewise, when economic conditions improve, demand and price tends to fall. Overlaid against this is demand from central banks across the world and exchange rate movements. The result is gold price volatility. Gold price AUD USD Dollar 2,000 per Troy ounce 1,600 1,200 800 400 0 Jan 1995 Jan 1997 Jan 1999 Jan 2001 Jan 2003 Jan 2005 Jan 2007 Jan 2009 Jan 2011 Source: S&P Dow Jones Indicies Since the Global Financial Crisis investors have invested heavily in gold. The increased demand buoyed prices, resulting in a 12.9% average annual price increase over the past five years. Prices peaked around September 2011 and, notwithstanding some short term fluctuations, remained at around that level until the end of 2012. The story in the first half of 2013 has been somewhat different. Gold price experienced significant erosion, falling to a current low of around AUD 1,400 per Troy ounce. Key drivers of gold prices: • World GDP • 90 day bank bill rate • AUD/USD exchange rate Jan 2013 8 With investor demand for safe-haven assets weakening against a backdrop of a strengthening US dollar and rising US bond yields, market conditions for gold have become less favourable. This is driving reduced investor net long positioning in the paper gold market and further reductions in the holdings of physically backed gold ETFs (exchange traded funds). Investor faith in gold has been further undermined by actions of the Indian government, which in April 2013 increased its import duty on gold from 6% to 8% to address its current account deficit. As the largest source of gold fabrication demand and trade, this increase in duty has had a strongly negative impact on import demand. Forecast gold price Current Estimated Dollar 2000 per Troy ounce 1600 1200 800 400 0 2010 2011 Source: Morgan Stanley Research 2012 2013 2014 2015 2016 2017 9 Industry revenue 10 The GFC and resultant resurgence in the price of gold revived the gold mining industry. Production and revenue was in decline in the early and mid 2000s but the industry has experienced growth in recent years. This growth has been driven both by increased revenue from existing production (as a result of the gold price increase) as well as increased investment in production capacity spurred on by the prospects of higher profits. In the past five years production has increased by 3% per annum and revenue has increased by 11% per annum. However, the recent fall in the price of gold will have a dampening impact on future revenue and production. Industry revenue Annual percentage change Revenue Billion $25 35% Forecast 30% $20 25% 20% $15 15% 10% $10 5% $5 (5%) 0% (10%) 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 (15%) Source: IBIS Research The recent fall in the price of gold has led some market commentators to question whether gold miners should have a more active gold price hedging policy. According to Thomson Reuters GFMS, the total amount of future gold production that is currently hedged is just over 100 tonnes, or 2.5% of annual demand. That is down from 75% at the end of the 1990s. At the turn of the century investors started calling for absolute exposure to rising gold prices and the major miners ended up spending billions of dollars to unwind their hedge books. We are unlikely to see a general market return to hedging. Those miners that currently have hedge positions are typically funding-related hedges, where lenders have required a portion of production to be sold forward as a condition of providing project financing for new mines. “IBIS forecasts revenue growth will moderate to 6.8% per annum over the next five years. Whilst around two thirds of the moderation is forecast to be accounted for by lower prices for gold ore, around one third of the moderation is expected to be driven by a moderation in gold ore production. In the past five years the rising gold price has allowed miners to expand production in existing mines and develop new mines that would have previously been uneconomic. The recent fall in gold prices will curtail much of this activity. But it also has implications for existing production.” IBIS Research 3 Cost accounting Cash costs form the foundation of mining performance measurement. However, disclosures have tended to underestimate the true costs of mining and selling an ounce of gold. New standards recently introduced by the World Gold Council will provide greater transparency but also materially increase reported costs. Gold miners have historically reported costs on a ‘cash cost’ basis that underestimated the costs of sustainable production. The World Gold Council has recently issued a guidance note on ‘all-in sustaining costs’ and ‘all in costs’ metrics that should provide greater clarity and transparency. Cash cost Adopted in 1996 - one of the first attempts to standardise cost reporting. Essentially the direct cost of mining and selling an ounce of gold. All-in sustaining cost All-in cost The ‘all-in sustaining costs’ is an extension of existing ‘cash cost’ metrics and incorporate costs related to sustaining production. The ‘all-in costs’ includes additional costs which reflect the varying costs of producing gold over the life-cycle of a mine. ‘Deferred stripping accounting’ was encouraged in 2002 to standardise the cost of waste stripping at open pit mines. Cash costs form the foundation of mining performance measurement. However, disclosures are not subject to accounting standards, are not standardised across the industry and have been open to smoothing and manipulation. Cash costs ignore many major imposts such as taxes, royalties, exploration, administration and capital expenditure. The gap between reported ‘cash costs’ and actual underlying costs has been growing for many years and a number of industry players have been calling for a more inclusive and transparent cost metric. “The companies talk about this cash cost measure with these ridiculous levels but you don’t see it ever come down to the bottom line as a profit. Companies are reporting profits now but ‘cash costs’ was a concept that came up because at one point, when gold prices were low, nobody made any money and no-one wanted to talk about being underwater although they were.” Ralph Aldis, US Global 12 The new metrics incorporate corporate overhead costs and reclamation and capital costs for current operations (all-in sustaining costs) and discontinued operations (all-in costs). As such, they provide a fuller picture of the true costs of mining and selling an ounce of gold. Direct mining costs Operational stripping costs Royalties and production taxes Third party smelting, refining and transport costs General and administration Community costs Reclamation and remediation Capital expenditure Capital exploration Capitalised stripping and underground mine development Cash cost All-in sustaining cost All-in cost On-site On-site and corporate On-site and corporate Current operations Current operations Current and discontinued operations Current operations Current and discontinued operations Current operations Current and discontinued operations Current operations Current and discontinued operations Current operations Current and discontinued operations The new guidelines are by no means perfect. Stringent definitions of by-product credits, sustaining capital, general and administrative costs and exploration spending are lacking and the guidelines do not account for acquisition costs, development capital, interest expense and taxes. The guidelines are also not a revolutionary concept. Many analysts have already been using this concept to derive their long term gold prices and many miners already report sufficient data to allow all-in sustaining costs to be calculated. However, what has been lacking is a universal formula. The new World Gold Council guidelines provide an opportunity for fuller and standardised cost reporting going forward. Whilst the guidelines are not mandatory, it is anticipated the majority of market players will adopt them. Other reporting options include Full Cost Reporting (all-in sustaining costs plus development capital) and Complete Costs Reporting (all-in sustaining costs plus development capital plus corporate taxes plus interest expense). “Now, we have a clear – well, clearer – definition of how much it costs not only to pull an ounce of gold out of the ground but, ensure that there will still be ounces of gold in the ground to pull out at a later date.” Moneyweb 13 The introduction of all-in sustainable cost reporting will materially increase reported costs. This highlights the significant cost inflation that occurred in the industry. Whilst the gold price has risen sharply over the past 13 years, costs have risen even higher. This has placed pressure on margins and, for marginal producers, has raised the prospects of mine closures. Average reported costs for the largest producers is estimated to increase from $672/oz (cash cost) to $1,086/oz (all-in sustainable costs) Estimated 2013 cash cost versus all-in sustainable cash cost 2013 cash costs 2013 AISC (all-in sustainable cost) Goldcorp Barrick Gold Newmont Mining Yamana Gold Randgold Kinross Agnico Eagle Mines Eldorado Gold Goldfields Centerra Average 0 200 400 600 USD/oz 800 1,000 1,200 1,400 Source: Agnico Eagle Complete cost versus gold price All-in sustaining cost Fully loaded all-in cost Gold price $1,800 Estimated $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 1970 1975 1980 1985 1990 Source: Scotiabank GBM For the first time since 2004, the complete cost for the industry is above the gold price. Although this was the case in the 1990s, when the price of gold was unsustainably low. With gold prices having increased by an average of 12.9% per annum over the past five years, the same cannot be said for the current situation. 1995 2000 2005 2010 2015 14 4 Cost structure The ‘goldilocks’ era of ever increasing gold prices is likely over and the industry must achieve higher productivity growth to avoid contracting profitability and mine closures. Whilst miners are firmly focused on cost savings, the challenge ahead is significant. Purchases 31.0% e Wages 11.9% Royalties 3.0% Contractors 20.0% Cost structure Purchases 31.0% Source: IBIS Research 16 Profit 23.0% The cost structure of gold miners is largely fixed, especially Cost structure in the short term and in relation to fully operational mines. Royalties Given 3.0% this, profitability tends to be volatile in line with Depreciation 11.1%movements in the gold price. Profit 23.0% ases 0% e % Purchases Wages 11.9% Royalties 3.0% 31.0% Contractors 20.0% Purchases 31.0% Source: IBIS Research 31.0% ases 0% 3.0% 11.9% 23.0% 11.9% Purchases relate mainly to fuel, electricity and chemicals, although also include 23.0%costs, administration 20.0% maintenance and cartage. Energy costs have increased significantly in recent years and are anticipated to continue to rise in the medium term.Profit 23.0% Profit 20.0% 11.1% 3.0% Average profit of 23% compares with 39% for all industries within the sector. Profit 23.0% Contractors 31.0% 20.0% 11.1% % 31.0% 1.1% Purchases 31.0% In order to take advantage of rising gold prices during the GFC, many gold miners 23.0%on mining contractors 20.0% relied heavily to provide the resources required to quickly 3.0% expand production. Contractor costs currently account for 20% of revenue, although the recent cost focus by gold miners in response to falling gold prices and rising costs, is likely to see reliance on contractors lessen. Wages 23.0% 11.9% 3.0% 20.0% for 11.9% of revenue Wages11.1% account 3.0%and have been increasing at an annual rate of 8.5% per annum over the past five years. This trend is expected to continue over the medium term. Depreciation 3.0% 11.9% 20.0% 11.1% 1.1% 3.0% Gold mining is capital intensive, reflective of average depreciation of 11.1% of revenue.3.0% For every dollar absorbed by wages, $0.94 is allocated to capital costs. This ratio is higher than mining generally (approx $0.70) and the average for all industries (approx $0.20). Net capital spending by the industry has been between $1.0 and $2.0 billion over the past five years. Royalties Source: IBIS Research The industry is subject to royalties imposed by state governments. Whilst the royalty percentages and method of calculation varies by state, they tend to average around 2% to 4% of revenue. Focus on costs 17 The ‘goldilocks’ era of ever increasing gold prices is likely over. To avoid the ‘bad news bears’ of falling terms of trade and ongoing low productivity growth (which would lead to contracting profitability or, worse, mine closures), the Australian gold mining industry must achieve higher productivity growth. Gold miners have recognised the challenges ahead and have initiated a renewed focus on costs and productivity. Compared with international gold mines, Australian gold mines tend to be small, with short lives. Whilst traditionally mined from underground mines, the rapid growth in gold production that occurred during the 1980s and 1990s was based on open-cut mining of large low-grade deposits that were previously uneconomical to extract. Cost inflation and falling gold prices are likely to place pressure on some of these lower-grade operations. Drivers of cost inflation Falling yields Labour g/t 2.0 Energy 1.5 State regulations 1.0 Lower grade deposit yields 0 2006 2007 2008 2009 2010 2011 Source: KordaMentha/333 Source: Goldfields Limited “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. “Other times miners simply structured their mines to maximise short-term output. Sometimes in minerals like 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.” Business Spectator Business Spectator Whilst gold miners are now firmly focussed on cost savings, achieving targeted savings will take time and capital. The only way to fix productivity problems is to undertake major changes in the way mines operate. Laying off a few workers will not address the issue. Significant investment is required, at a time when revenue and profitability is under pressure from falling prices. Targeted cost savings General contractor prices Corporate overheads 22% 13% Blasting costs 13% Direct labour costs 13% Reduced contract mining 7% Transport costs 7% Reduced maintenance 7% A recent survey of Australian mining and metals firms by Morgan Stanley highlighted the extent of cost savings targeted by the Australian mining industry as a whole. On average respondents were seeking cost savings in excess of 20% in relation to general contractor prices and almost 15% savings in overheads, blasting costs and direct labour costs. The initial focus will be on general contractor prices, followed by transport costs and corporate overheads. Labour costs will not be targeted for immediate savings. This reflects the perceived difficulty in achieving costs savings in areas such as labour costs. General contractor prices will be targeted first 1 = Fastest execution General contractor prices Transport costs Corporate overheads Blasting costs Reduced contract mining Direct labour costs Reduced maintenance 0 1 2 3 4 5 6 7 8 9 10 9 10 Direct labour is seen as the most resistant to cost saving initiatives 1 = Most resistant Direct labour costs Blasting costs Corporate overheads Transport costs Reduced contract mining General contractor prices Reduced maintenance “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... 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.” Business Spectator 0 1 2 3 4 5 6 7 Source: Morgan Stanley Australian Mining Cost Survey 8 18 5 Outlook Investors expect gold miners to deliver returns leveraged to the gold price. These expectations have not been met and a paradigm shift is required to regain investor confidence and build sustainable production against a backdrop of lower gold prices. Market performance 20 Whilst ASX listed gold miners have outperformed both the metals and mining sector and the All Ordinaries as a whole for most of the past five years, the recent fall in gold prices has reversed this position. Peformance for past five years Peformance for past year S&P/ASX 300 Metals and Mining All ordinaries All ordinaries - gold S&P/ASX 300 Metals and Mining All ordinaries All ordinaries - gold 250 250 200 200 150 150 100 100 50 50 0 2008 2009 2010 2011 2012 2013 0 2008 2009 2010 2011 2012 2013 Source: Capital IQ Source: Capital IQ The falling gold price and declining gold valuations have driven substantial non-cash asset impairments, write-downs and restructure costs for most industry players. And, in turn, these have negatively impacted market price performance and market valuation. Recent selected impairments and writedowns Company Writedown Barrick Gold $8.7 billion Newcrest Mining $6.0 billon Kinross Gold $2.3 billion Goldcorp $2.0 billion Newmont Mining $1.8 billion Evolution Mining $375 million Oz Minerals $220 million Resolute $70 million Ramelius Resources $58 million Source: Various Top ten ASX gold miner price change Market Price change capitalisation % (1 year) Newcrest Mining 9,026.2 (50%) Regis Resources 1,650.6 (26%) Millennium Minerals 616.2 (26%) Evolution Mining 570.0 (50%) Beadell Resources 551.8 9% Resolute Mining 468.3 (47%) OceanaGold Corporation 444.3 (35%) Medusa Mining Limited 392.9 (59%) Northern Star Resources 350.0 (15%) Papillon Resources 320.7 (8%) Source: Capital IQ A paradigm shift 21 Investors expect gold miners to deliver returns leveraged to the gold price. These expectations have not been met and a paradigm shift is required to regain investor confidence and build sustainable production against a backdrop of lower gold prices. Gold price and gold equity returns (2008 - 2013) Gold Price (AUD) Gold All Ords Gold 200 Price (AUD) 180 160 2,000 Gold All 1,800 Ords 1,600 140 1,400 120 1,200 100 1,000 80 800 60 600 40 400 20 200 0 Aug 2008 Source: Capital IQ 0 Feb 2009 Aug 2009 Feb 2011 Aug 2010 Feb 2011 Aug 2011 Feb 2012 Aug 2012 Feb 2013 Action plan 22 A high gold price created an environment where production volume at almost any cost still drove returns. Going forward, miners will need to focus more closely on maximising riskadjusted rates of return and free cash flow. Reduce operating costs Remove high cost production Individual asset by asset focus • Reconfigure for lower activity • Contract renegotiations • Labour reductions • Optimise production • Defer capital and stripping • Utilise stockpiles • Operate for free cash flow neutral or positive outcomes at every asset • Review portfolio to optimise cash generation • Delay expansion, exploration Reduce capital, exploration and studies • Prioritise low risk, high return brownfield growth opportunities • Pursue greenfield opportunities only if they offer attractive, risk weighted returns • Seek opportunistic M&A of in-production assets where the path to value is clear ”Returns will drive production. Production will not drive returns” Barrick Q2 2013 results presentation “Australian goldminer Focus Minerals has closed down its operations completely because of the slump in the gold price.” Australian Financial Review, 17 July 2013 Mine strategies 23 Over the past few years miners have adopted a ‘Grow’ or ‘Grow +’ mining strategy in order to capitalise on the rising gold price. As gold prices fall, strategies will shift to ‘Sustain’ or, in the case of the least economic mines, ‘Defend’. Activity Capital AISC* Cash flow Maximum mining Growth capital Lowest Optimised for highest gold prices Expansion capital Lower Optimised for higher gold prices Sustaining capital Higher Optimised for lower gold prices Plant-critical capital Highest Optimised for lowest gold prices Grow + Low gold prices cash flow scenarios High gold prices growth scenarios Growth Plant extended Cash flow Long life Grow Growth Accelerate mining Plant expanded Cash flow Long life Sustain Growth Limit mining Plant optimised Cash flow Long life Defend Growth No mining Plant run as-is Cash flow Long life * All-in sustaining cost Source: Newcrest Mining 2013 Financial Year results presentation Contacts Melbourne Sydney Perth Level 24 333 Collins Street Melbourne Vic 3000 Level 5 Chifley Tower 2 Chifley Square Sydney NSW 2000 Level 11 37 St Georges Terrace Perth WA 6000 Tel: Fax: Tel: Fax: Tel: Fax: +61 3 8623 3333 +61 3 8623 3399 +61 2 8257 3000 +61 2 8257 3099 +61 8 9220 9333 +61 8 9220 9399 [email protected] [email protected] [email protected] Brisbane Townsville Singapore Level 14 12 Creek Street Brisbane Qld 4000 Level 6 75 Denham Street Townsville Qld 4810 16 Collyer Quay #30-01 Singapore 049318 Tel: +61 7 3338 0222 Fax: +61 7 3338 0298 Tel: Fax: Tel: Fax: [email protected] [email protected] Adelaide New Zealand Level 4 70 Pirie Street Adelaide SA 5000 Level 16 Tower Centre 45 Queen Street Auckland 1010, New Zealand Tel: Fax: Tel: Fax: +61 8 8212 6322 +61 8 8212 2215 [email protected] +61 7 4724 5455 +61 7 4724 5405 +65 6593 9333 +65 6593 9399 [email protected] +64 9 307 7865 +64 9 377 7794 [email protected] www.kordamentha.com This publication, and the information contained therein, is prepared by KordaMentha Partners and staff. It is of a general nature and is not intended to address the circumstances of any particular individual or entity. It does not constitute advice, legal or otherwise, and should not be relied on as such. Professional advice should be sought prior to actions being taken on any of the information. The authors note that much of the material presented was originally prepared by others and this publication provides a summary of that material and the personal opinions of the authors. Limited liability under a scheme approved under Professional Standards Legislation.
© Copyright 2024