While falling commodity prices dominated headlines in 2014, a closer look at the developments in the past year reveal a more complex picture. A combination of slowing economic growth in China, continuing commodity supply levels and volatile, but generally lower, commodity prices made for a rocky year for mining companies. It’s not all bad however - at the same time Australian miners have benefited from a depreciating Australian dollar which has increased Australian dollar denominated revenues, a falling oil price which has helped to reduce costs and a relatively steady demand for bulk commodities (albeit at a slower rate of growth).
Here we take stock of the major trends that we observed in mining in 2014 and discuss what we expect to see in the mining sector in 2015.
Access to capital
The announcement of the US$7.2 billion financing of the development of the Roy Hill iron ore project in early 2014 – the largest debt financing of a mining project in the world in 2014 – was a positive development in a challenging climate for mining companies seeking to access capital in 2014. The success of the Roy Hill financing demonstrated the availability of very significant amounts of capital for large-scale, long-life resources projects such as iron ore projects in the Pilbara region of Western Australia and coal projects in Queensland.
Junior miners, however, continue to face challenges in raising equity, due in part to the heightened risk presented by single-project or single-commodity companies. Junior explorers in particular, have faced difficulties in accessing equity capital as investors’ appetite for risk has evolved.
M&A has become an important form of capital raising, particularly between single-project companies and companies with cash generating projects or cash on their balance sheet. This trend has been particularly noticeable in the gold sector and we expect it will continue during this period of low commodity prices. In 2014 we also saw an encouraging return of large public M&A transactions in the mining sector as well as an increased willingness by bidders to launch hostile transactions, signalling what we expect will be the start of a rebound in mining related M&A activity.
Although there was a reduction in investment by Chinese SOEs in Australian mining in 2014, we also saw private equity firms hunting bargains in the mining sector. A Chinese private equity fund made a substantial investment in an Australian headquartered mining company and a number of mining focused private equity funds were focused on opportunities in the Australian market. At a low point in the commodity price cycle, we expect private equity interest to continue, subject to the funds having a view that higher prices will return within their investment horizons. We also expect to see a rise in less conventional financing approaches such as revenue stream and royalty sales and convertible instruments which offer the certainty of debt with the up side of equity.
While the news of easing Chinese GDP growth and a cooling property market in China was met with some nervousness last year, the overall trend in 2014 was one of continuing demand for bulk commodities, albeit at a lower rate of growth.
The Chinese government’s focus on reducing air pollution has placed pressure on Chinese steel mills to reduce emissions. This should lead to sustained demand for high grade, low emissions products (particularly coal) that account for a significant part of Australian exports to China. The announcement of the China-Australia Free Trade Agreement in late 2014 was also welcome news to Australian miners. The implementation of the agreement will see the abolishment or gradual phasing out of tariffs on coal, copper, uranium, titanium, nickel, zinc and alumina.
India, too, looks poised to become an important destination for Australian commodity exports in the near term. As the country’s rapidly growing population and economy begin to stretch India’s domestic supply of coal and iron ore, India is set to look overseas to satisfy the growing supply gap. Adani’s proposed Carmichael coal mine in central Queensland, Australia – slated to become one of the biggest coal mine in the world – is an example of India’s need to secure energy sources to meet domestic electricity demands.
Access to infrastructure
Access to infrastructure and capacity constraints continue to be a challenge for Australian mining projects, in particular in bulk commodity projects.
To get products to market, infrastructure users have sought to fund the expansion of key infrastructure assets, such as port and rail. Though less common, infrastructure providers have also made equity investments in end users. Shared access to fully utilise existing infrastructure that is within a reasonable distance of potential projects will also continue to be an option that is considered.
The proposed privatisation of a number of infrastructure assets (in particular ports) being considered by government may increase capital flows, though the recent Queensland election may see privatisations there being shelved. To the extent privatisations proceed, they may also result in attractive investment opportunities for infrastructure investors (pension/superannuation/infrastructure funds) and assist with the development of the next generation of port and rail infrastructure which will be necessary to grow the Australian mining industry.
Reducing costs, increasing productivity
High costs and falling revenues meant that mining companies have held back on greenfield developments in 2014. Those with high cost operations have substantially scaled back their operations until commodity prices improve and the large diversified mining houses have favoured a strategy of sweating their existing assets.
BHP Billiton and Rio Tinto conducted cost cutting drives to reduce their unit cost of production and increase productivity, both very successfully. These measures, have been combined with a ramp up in production to increase revenues in order to maintain profits in an environment of low commodity prices.
In addition, BHP Billiton announced the spin-off of its non-core assets in order to focus on its low cost assets and other miners have sought to sell non-core assets including mines and associated equipment. These sales have resulted in opportunities for those in mid-tier with access to funding to increase the scale of their companies and diversify their operations to reduce single-project risk.
There is a growing awareness among mining companies that technological innovation, which can enable mining companies to streamline production, reduce bottlenecks and reduce labour costs, will be critical in keeping rising operational costs in check and increasing productivity. Automation, in the form of remote operations technologies, is already an increasing feature of the larger mining operations. We expect this trend will continue and that the use of mining technology will become more widespread as the costs decrease over time.
Overseas assets and operations
Recent years have seen Australian headquartered mining companies export their expertise by developing mining assets in Africa, Asia and South America. Whilst these companies stand to profit from exciting opportunities in emerging markets, they are also faced with challenges inherent in operating in countries with less certain legal systems, corporate governance regulations and political stability. These jurisdictional differences expose mining companies and their investors to regulatory uncertainty which can have significant financial implications that, in the worst case scenario, may involve the expropriation of the overseas asset.
In an effort to protect Australian investors from potentially risky investments, the Australian Securities and Investment Commission recently announced that it will review corporate documents, including prospectuses, released by locally listed mining companies with overseas assets, to ensure compliance with corporate governance standards. ASIC has indicated it will require companies to more fully disclose legal and regulatory risks to potential investors.
Flow on effects
As could be expected, Australian miners doing it tough had significant flow on effects for those in mining services industries such as mining contracting and equipment. The move from construction to production, compounded with low commodity prices which have slowed development, placed significant pressure on the margins and order books of mining contractors and equipment providers in 2014. Many mining contractors have undertaken similar cost reduction and rationalisation measures to their customers in a bid to maintain profitability and this looks set to continue in at least the short term.
In a low price and cost constrained environment we are also seeing an increased propensity for contractual disputes in the mining sector – with principals looking more closely at compliance with construction and operating contracts and joint venture parties seeking to enforce their rights more strenuously, be it in relation to decision making, information access or marketing.
The macroeconomic environment in 2014 for miners has also been a focus of the Federal and State Governments. In September, the Federal government fulfilled its election promise of repealing the mining resources and rent tax, which would have placed further financial pressure on miners.
Governments are also facing significantly reduced royalties from mining operations, with budgets being adversely affected and potential effects on credit ratings. This hole in revenues raises the possibility of State Governments revamping royalty regimes. While both Labor and the Liberal National Party in Queensland ruled out any increases to royalty rates ahead of the recent election, in Western Australia, the State Government is undertaking a 3-year review of the current royalty system ahead of the 2015-16 State budget. The West Australian Government has also announced that it will consider granting royalty relief to junior iron ore miners on a case by case basis during periods of low iron ore prices. Haematite miners would be eligible to apply for a 50% rebate on royalties for up to 12 months while the iron ore price remains below A$90 per tonne, commencing in the December 2014 quarter. The rebate would repayable in the following 2 years.
In summary, although the initial exuberance of the mining boom years may be over, steady demand from existing customers and opportunities in new markets means miners that are able to adapt to the current challenges through containing costs and increasing productivity may benefit from the significant opportunities created by the current challenging market conditions.
This article was written by Bryan Bong, Solicitor, Perth