No Security of Supply

Richard (Rick) Mills
Ahead of the Herd

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As a general rule, the most successful man in life is the man who has the best information

The truth, in regards to the world’s mineral resources, is that we in the western developed countries are not in control of supply. The map below was posted on reddit.com. While interesting it does not reveal the enormity facing the western world in regards to Security of Supply for many of our key minerals.

“The spectre of resource insecurity has come back with a vengeance. The world is undergoing a period of intensified resource stress, driven in part by the scale and speed of demand growth from emerging economies and a decade of tight commodity markets. Poorly designed and short-sighted policies are also making things worse, not better. Whether or not resources are actually running out, the outlook is one of supply disruptions, volatile prices, accelerated environmental degradation and rising political tensions over resource access.” Chatham House, Resources Futures

There are many serious concerns in regards to global resource extraction that we need to consider:

• Resource nationalism/Country risk, political instability of supplier
• A looming skills shortage
• Competition with Chinese mining investment, smaller areas open for exploration
• Low hanging fruit – the high quality large deposits have already been found, lower economic attractiveness of new projects, cost inflation
• Supply bottlenecks for much needed and scarce equipment
• The manipulation of supplies ie speculation and concentrated ownership of LME stocks
• Rising capex/opex, lack of financing options, capital project execution
• Lack of innovation and technological advancements
• Declining open pit production, ongoing operational issues
• Lack of recognition for population growth, growing middle class w/disposable incomes and urbanization as on-going demand growth factors
• Environmental group and labor risks, mining unrest – lack of a social license to operate, incredibly difficult and lengthy permitting processes
• Climate change, accidents and natural disasters
• Lack of infrastructure or poor infrastructure access, attacks on supply infrastructure
• Price and currency volatility
• Fraud and corruption

Let’s take a hard look at Costs, some examples of growing Resource Nationalism and Civil Unrest Directed Towards Mining and lastly Population Growth & Urbanization.

Costs

Mining is an extremely capital intensive business for two reasons. Firstly mining has a large, up front layout of construction capital called Capex – the costs associated with the development and construction of open-pit and underground mines. There are often other company built infrastructure assets like roads, railways, bridges, power generating stations and seaports to facilitate extraction and shipping of ore and concentrate. Secondly there is a continuously rising Opex, or operational expenditures. These are the day to day costs of operation; rubber tires, wages, fuel, camp costs for employees etc.

Copper mining has become an especially capital intensive industry – the average capital intensity for a new copper mine in 2000 was between US$4,000 – 5,000 to build the capacity to produce a tonne of copper, now capital intensity is north of $10,000/t, on average, for new projects.

The same trends are also evident for new nickel mines, where capital intensity has gone through the roof:

• Capital costs on a per pound basis escalating rapidly over the last decade
• The discrepancy between the initial per pound capital cost of nickel projects, and the ultimate construction costs, are over 50 percent
• Economies of scale have not been reflected by lower unit capital costs – large projects have similar or even higher capital intensity

Global nickel supply is increasingly going to come from laterite nickel deposits, and the high-pressure acid leach (H-Pal) plants to treat the ore require much bigger investments – there is often significant cost and technical challenges associated with laterite projects.

We are now looking at north of $35/lb capital intensity as we move into these very large ferronickel and H-Pal projects that are requiring many billions of dollars to build.

Capex costs are escalating because:

• Declining ore grades and more complex metallurgy means a much larger relative scale of required mining and milling operations
• A growing proportion of mining projects are in remote areas of developing economies where there’s little to no existing infrastructure

Chile is the world’s top copper producer but the country as a whole is woefully short of power. The country’s power generation capacity currently stands at 17,000 megawatts. It is estimated that the country will need at least 30,000 megawatts of power by 2020 to keep up with the demand, the increased demand coming primarily from mining projects.

Unfortunately the government only plans to add 8,000 megawatts between now and 2020 and there is serious opposition to these plans from environmental groups who have, so far, been wildly successful by suspending several key projects and more than $22 billion worth of power investment. The Chilean Supreme Court recently struck down the planned 2,100-megawatt, $5 billion Castilla thermoelectric power plant project, citing environmental concerns.

Codelco, the Chilean state owned copper company, and the world’s largest copper miner with 20% of global copper reserves, said that their 2012 first half copper production fell 6.4% because of lower grades mined. Codelco’s direct cash costs increased 27% year-on-year mostly because of paying higher prices for electricity from the drought stricken SIC grid.

Many copper mining companies are having to go back to the drawing board in regards to their economic studies trying to lower their cost of production.

With the lower grades of ores now being mined energy becomes more and more of a factor when considering economics. The cost of energy is climbing, the amount used is climbing but the returns from energy expended is declining. Eventually the quantity of resources used in the extraction process will be 100% of what is produced.

The bottom line? It is becoming increasingly expensive to bring new mines on line and run them.