Tài liệu Business risks facing mining and metals 2012–2013 pptx

Capacity changes in terms of skills and infrastructure which have affected organizations’ short term commitment to capital projects with life of mine of at least 10 years Resource nation

Business risks facing

mining and metals

2012–2013

Organizations that succeed do so

because they are best able to optimize the risk and reward equation for both strategic and operational issues.

Editorial — Prospects and perils:

facing up to political risks in mining and metals 28

The risks closest to the center of the radar are those that pose the greatest challenges to the mining and metals sector in 2012 and into 2013.

The Ernst & Young

business risk radar

for mining and metals

Executive

summary

On the surface, the top ten risks don’t look all that different from last year, but below the surface there has been an absolute shift that has made them signifi cantly different The risks facing the sector have become more extreme and more complex over the past 12 months due to the fast changing investment and operational environment Two signifi cant contributing factors are:

1 Softening commodity prices which have seen mining and metals companies taking on more risk relative to the short term returns

2 Capacity changes in terms of skills and infrastructure which have affected organizations’ short term commitment to capital projects with life of mine of at least 10 years

Resource nationalism retains the number one risk ranking as governments seek to transfer even more value from the mining and metals sector Many governments around the world have now gone beyond taxation in seeking a greater take from the sector, with a wave of

requirements introduced such as mandated benefi ciation, export levies and limits on foreign ownership

There is no doubt projects around the world have been deferred and delayed, and in some cases investment withdrawn altogether, because of the degraded risk/reward equation The uncertainty and destruction of value caused by sudden changes in policy by the governments

of resource-rich nations cannot be understated Mining and metals companies looking to preserve value are actively negotiating value trade-offs with less politically sensitive policies than resource nationalism As this risk continues to grow in signifi cance, we don’t expect a slowing in this trend Indeed, mining and metals companies must continue to engage with governments to foster a greater understanding of the value a project brings to the host government, to better communicate the implications of changes in the risk/reward equation, and to more effectively negotiate appropriate trade-offs that preserve the value to both the companies and the governments

A more complex and extreme

risk environment

“The bottom line is that if returns start to wane,

then there is a greater imperative for organizations to tightly and more effectively manage their risks to maintain an adequate

risk/reward balance.”

Mike Elliott

Global Mining and Metals Leader, Ernst & Young

Global skills shortage and infrastructure access retained second and third spots on the risk rankings this year Both these risks are more acute in more locations now than they were

12 months ago, highlighting the supply capacity constraints that have hampered the sector for some time Rapidly escalating costs over the past year, where rising prices have not covered this impact, have brought further challenges for mining and metals companies, pushing cost infl ation up from number eight to four on our risk rankings

Sharing the benefi ts makes its debut at number nine this year The relative prosperity of the mining and metals sector at a time when many other sectors in the global economy are struggling has seen this new risk emerge for mining and metals companies Stakeholders ranging from the government to employees, the local community and suppliers, feel they are entitled to a greater proportion of value created by mining and metals companies This has forced companies to balance the expectations and the needs of their many

stakeholders When they fail to do so, it results in strikes, supply disruptions, shareholder activism and governments using their power to achieve their portion through resource nationalism Miners are willing to yield some returns on the appropriate transfer of risk to stakeholders However, many of the stakeholders, who want an increased share of the mining and metals profi ts, are not taking on additional risk for their increased return, leaving the mining and metals companies to carry all of the risk

Rounding out the top 10 risks are cost infl ation, capital project execution, social license to operate, price and currency volatility, capital management and access, and fraud and corruption, with almost all of the top 10 risks more complex and more critical for mining and metals companies now than they were last year

So although we haven’t seen large changes in the ranking of risks year on year, the bigger swings are evident over the medium term Five of the risks have consistently remained crucial risks over this period, while the remaining fi ve have fallen out of the top 10 table altogether

In a rising market, the returns have justifi ed taking on more risk While the demand outlook remains strong, the price peaks have passed and so there is a much greater imperative for mining and metals companies to remain nimble and sure-footed in how they manage these fast-changing risks in order to balance the relative risk/reward equations demanded by both the Board and shareholders

Top ten risks over fi ve years

01 Skills shortage

02 Industry consolidation

03 Infrastructure access

04 Maintaining a social license to operate

05 Climate change concerns

06 Rising costs (cost infl ation)

04 Cost infl ation

05 Capital project execution

06 Maintaining a social license to operate

07 Price and currency volatility

08 Capital management and access

new Sharing the benefi ts

10 Fraud and corruption

Remained in the top 10 over 5 years

The top 10 business risks for

mining and metals

Resource nationalism

Resource nationalism retains the number one risk ranking with

many governments around the world going beyond taxation in

seeking a greater take from the sector, with a wave of

requirements introduced around mandated benefi ciation, export

levies and limits on foreign ownership

The uncertainty and destruction of value caused by sudden

changes in policy by the governments of resource-rich nations

cannot be understated as projects around the world have been

deferred and delayed, and in some cases investment withdrawn

altogether because of the changed risk/reward equation

Miners should continue to engage with governments to foster a greater understanding of the value a project brings to the host government and be better able to negotiate appropriate trade-offs that preserve the value to both mining and metal companies and governments This includes encouraging governments to take a broader view of the return from natural resource development, as well as negotiating tax incentives and offsets

Skills shortage

The acute skills shortage seen in Australia and Canada has spread

to more places during the past year, with projects in Indonesia,

Mongolia, Brazil, Chile, Peru and Mozambique all plagued by this

challenge Strong commodity prices and confi dence in the

long-term sector fundamentals have reinvigorated investment in

mining and metals to quickly develop new projects or ramp up

production from existing ones This increased investment is in turn

driving demand for skilled workers around the world and drawing

on the same global pool of talent The risk is that this could slow

growth and increase costs

Signifi cant risks associated with skills shortage include impact to

production, project delays, and increasing labor costs Identifying,

attracting and retaining critical operational and construction skills remains a top priority for the mining and metal sector Innovative approaches used by organizations include:

1 Differentiated employee value proposition — to retain

employees, companies are offering not only attractive compensation but also individually tailoring non-fi nancial benefi ts

2 Accessing non-traditional and underrepresented labor

pools — such as women and indigenous communities

3 Resourcing from other sectors — companies are hiring

resources from industries with similar and/or complementary skills, such as oil and gas, and manufacturing

Infrastructure access

The long running minerals super-cycle has made lower quality or

remote deposits viable, with the lack of suffi cient infrastructure

being the primary obstacle to the development of these resources

Governments are no longer the natural vehicle through which

infrastructure projects are funded, mainly due to their current

weak budgetary positions This means that fi nancing has fallen to

the private sector Large miners with balance sheet strength are

under increased shareholder pressure to restrict new capital

expenditure, and small miners often lack required fi nancial

strength to solely develop these projects

The key infl uences on infrastructure fi nancing include:

• The changing role of government to planning, approving and

incentivizing fi nancing of infrastructure

• The rising number of foreign investors in infrastructure from

countries like China, Japan, Korea and India

• Funding from institutional investors including pension, sovereign wealth and infrastructure funds

• The increasing focus on corporate governance which has seen closer Board scrutiny of the return on investment which often results in projects with large infrastructure needs being less likely to be approved

To fulfi l infrastructure needs, changes need to be made to procurement processes and risk allocation between government, users, developers and funders For this to be effective, traditional views around construction risk, residual value, revenue/pricing risk, capacity, operational control, credit risk and tax need to be re-assessed Unless the commercial risks can be adequately addressed and the take or pay contracts be bankable, then development of infrastructure will continue be slower and more complicated than would appear necessary

Capital project execution

There is a massive pipeline of projects in 2012–2015 At the same

time, there has been high delivery cost infl ation and heightened

macroeconomic uncertainty This uncertainty has been putting

downward pressure on prices of mined commodities since 2H

2011, with mining and metals companies now reconsidering,

revising and prioritizing or sequencing previously announced

capital project plans to mitigate these factors

Mining and metals companies are adapting to emerging capital

project risks by:

• Raising the bar on business case justifi cation and rigor —

there is a renewed focus on the integrity of data around

estimated project costs and benefi ts to aid/improve management’s level of decision-making confi dence

• Prioritizing the investment pipeline to align with a changing

appetite for cost and cash exposure — as leadership teams

develop customized criteria to sequence their project pipeline, prioritization considerations extend beyond return on

investment to strategic alignment, cash fl ow exposure and delivery complexity

• Enhancing project controls to drive standardized delivery

against plan — project teams must embed the right project

control disciplines to drive delivery against plan in a standardized and consistent manner

Maintaining a social license to operate

The consistent ranking of maintaining a social license to operate

within the top six risks over the last fi ve years demonstrates it is

an important element of doing business as opposed to being a

compliance exercise While the reputation of being a company

which does the right thing can provide a competitive edge through

better access to capital and solid government relationships, it is

essential in being able to access the next project Trends which

challenge companies include:

• Increased expectations — stakeholders such as governments

and communities want more from mining and metals

companies operating in their jurisdictions, from basic fi nancial

returns to benefi ts for the community and the country To stay

ahead, companies need to be proactive, timely and transparent

in their dealings with these stakeholders

• Acquisition challenges — Acquisitive companies need to be

increasingly aware of the standards of their potential targets, moving quickly to set clear expectations of how they do business and build fi rm partnerships with stakeholders

• Changing how business is done — companies are changing how

they approach business by focusing more closely on building strong partnerships with stakeholders and communities right from the start so they are engaged and understand every aspect of the project

Price and currency volatility

Equity markets are becoming increasingly sensitive to

macroeconomic news, and for many organizations increases in

commodity prices are often not fully impacting share prices,

whereas decreases are The erosion of the gold premium is a

prime example This is creating differing asset valuation

expectations, impacting the ability to complete transactions

Companies’ operating costs are often not in their functional

currency, and therefore volatility in foreign exchange prices can

put extreme pressure on them To combat this volatility, mining

and metals companies need to consider metals price and currency

hedging strategies, and hedging inputs to production Scenario

planning could help them assess their ability to withstand price

shocks and capitalize on the current metal price cycle

During periods of great volatility, mining and metals companies most value fl exibility to vary the level of production at little or no cost Dynamic Discounted Cash Flow (DCF) and Real Option (RO) modelling are providing decision-makers with enhanced cash fl ow models that improve risk assessment and fi nancing options of mining projects Only a handful of mining and metals companies are, however, implementing these techniques and generally seem

to be battling with scenario planning We expect to see increasing board level focus on currency and metal price volatility strategy and management as they strive to recognize and exploit value from volatility

Cost infl ation

Cost infl ation in the sector is expected to intensify over the next

several years, due to a number of factors, including labor, energy,

ore grades, currencies, supplier constraints and taxes In the

prevailing environment of global economic uncertainty, softening

commodity prices, higher input costs, and strengthening local

currencies in many mining and metals jurisdictions are increasing

the pressure on margins

Companies are revisiting their capital expenditure plans as

spiraling capital costs threaten the viability of new projects Furthermore, high crude oil prices, wage infl ation and increasing complexity are driving operating costs In response, mining and metals companies are reviewing their portfolios to identify underperforming assets, with plans to shut down or divest high cost and non-core assets Industry consolidation, automation technology, owner-operated mines and investment in energy assets are some of the steps that companies are taking to lessen the impact of rising costs

Sharing the benefi ts

As the mining sector continues to fl ourish while other sectors

fl ounder, a wider range of stakeholders are looking for a greater

share in the perceived profi ts These stakeholders feel entitled to a

portion of the value created by mining and metals companies and

balancing these varied and competing expectations is challenging

• Governments are placing pressure on mining and metals

companies to take a greater role in supporting the broader

community through social and logistical infrastructure,

community developments, and local hiring and procurement

practices

• Local communities are not just looking for minimal disruption

but also to share the economic and social benefi t from local

mine operations They have a lot of power to disrupt projects if their needs and interests are not met

• Employees are seeking higher wages and greater workplace

benefi ts and can incite industrial unrest if they are not achieved

• Suppliers can charge greater premiums as mining and metals

companies are dependent on their goods and services to increase production output

• Shareholders are expecting a greater return on their

investments for the perceived risk of owning mining and metals stock, squeezing the profi ts already shared amongst the other stakeholders

Fraud and corruption

Fraud and corruption remains on this year’s risk radar due to the

increased political risk we’ve observed in a number of key mining

and metals companies’ investment destinations, and also

increased regulation and enforcement activities The effects of

fraud and corruption can impact a company’s reputation, social

license to operate and bottom line Additionally, the extent of

fraud and corruption and the associated effect on both private and

public citizens of countries have led governments to implement far

reaching regulatory changes

In response to new regulation and enforcement, companies are

actively changing the way they do business:

• Compliance monitoring — this is becoming crucial in itself and

additionally many companies are seeking assurance of their compliance

• Third party liability — mining and metals companies are

substantially increasing due diligence initiatives around third parties as part of their corruption gap analysis, which includes specifi c anti-corruption provisions in their standard contract terms

• Whistle-blowing — companies have been forced to become

active in encouraging internal whistle-blowing by providing a credible alternative to external whistle-blowing

Capital management and access

Boards in 2012 are facing an extremely complex and uncertain

environment within which to undertake capital allocation

decisions The volatility seen on capital markets is raising the risk

that funding to the sector could become increasingly limited

Rising cost infl ation and a volatile investment backdrop are

challenging the returns expected on major organic growth

programs And an apparent undervaluation by the markets,

amidst increasing pressure for greater return of capital to

shareholders, is driving companies to revisit their overarching

capital allocation strategies

The risk of sub-optimal allocation of capital can have a signifi cant and long-lasting impact Companies are responding to this risk by building options and fl exibility into their capital agendas through:

• Opportunistic refi nancing

• Strategic divestments and reallocation of capital

• Innovative approaches to capex disciplineThe challenge for mining and metals companies is to remain true

to their long-term strategy, while building in fl exibility to respond

to short/medium term opportunities and risks

The top 10

business

risks

Resource nationalism continues to be the number one risk facing

mining and metals companies as governments go beyond taxation

in seeking a greater take from the sector The uncertainty and

destruction of value caused by sudden changes in policy by the

governments of resource-rich nations cannot be understated.

We are observing three key trends of resource nationalism which

we will believe will continue throughout 2012/13:

1 Imposition/increasing of royalties or mining taxes

Amendments to mining and tax laws can result in changes to capital

allocation based on a weaker risk/reward profi le

The announcement in 2010 of a proposed new ‘super profi ts’

mining tax in Australia had a signifi cant ripple effect around the

world Many mining and metals jurisdictions announced increases in

taxes and royalties during the course of 2011–12 and many looked

at Australia’s action as commercial cover for proposed changes For

example, in March 2012, an Indian Government taskforce started

working on modalities for a new levy on minerals mined on forested

regions of the country The proposal for a new levy followed

demands raised by several provinces in India for a new mineral

resource rent tax with a minimum of 50% on ‘super profi ts’ earned

by miners The provincial governments had suggested modelling

the new resource rent tax along the lines of the Australian

proposal.1

Other tax and royalty increases are being proposed and enacted

across the world in the resource rich emerging markets After the

2011 elections, Peru enacted a new mining tax and royalty regime

that used as a template similar changes that occurred in Chile the

year before These levies are based on net mining income with

certain adjustments, e.g., interest expense is not allowed as a

deduction

During 2011 and for the fi rst six months of 2012, a number of

countries have announced or enacted increases to taxes or royalties

including Democratic Republic of Congo, Ghana, Mongolia, Peru,

Poland, and the USA, to name a few

1 India working on mining tax, Mining Weekly, 20 March 2012

2 Mandated benefi ciation/export levies

Many governments are now seeking to have minerals benefi ciated in-country prior to export South Africa has announced a

benefi ciation strategy, as has Zimbabwe, Indonesia, Brazil and Vietnam In theory, this will capture more of the value-chain as the products will achieve higher prices

Changes to the risk profi le due to mandated benefi ciation include:

• The high cost of establishing refi neries or smelters if not already established in the country

• The need for both low cost power and infrastructure for benefi ciation plants — both of which are often in short supply in these countries

• The need for skilled labor for value-added processing

• Loss of fl exibility in global supply chain

• Concentration of investment risk

• Relatively higher taxes on value add

• Less integration with customers supply chain

• Threats to existing business models where miners are forced to move downstream

Typical of the reaction to mandated benefi ciation came from one company which made the following comment on the changes to the Indonesian export regime — while they were happy to commit US$500m to Indonesia for a mine, they were not happy to commit US$1.5b for a mine and a smelter as the returns did not justify that much exposure to the country.2

In order to better ensure in-country benefi ciation, governments are imposing new steep export levies on unrefi ned ores For instance Indonesia, as part of its mining tax changes, has proposed a new export levy of 25% on mining exports in 2012, increasing to 50% in

2013 The Indonesian Government said in announcing the proposal that it is seeking to develop its mining sector, create jobs and turn itself into a producer of higher value fi nished goods from an exporter of raw materials

2 Anonymous company quote to Ernst & Young contact

01

Resource nationalism

(same as 2011)

3 Retaining state or national ownership of resources

Governments are also seeking to ensure that they retain ownership

of their minerals, which is not a new phenomenon While trying to

eliminate discussion about nationalization, South Africa, which

already has Black Economic Empowerment (26% participation), is

also canvassing the idea of the mandatory participation of a state

owned mining company Indonesia has announced a plan to limit

foreign ownership of mines to 49% after 10 years Zimbabwe has

already commenced its 51% indigenization laws, and Mongolia has

placed a 49% cap on foreign ownership of strategic mines China

and India have restrictions on foreign ownership of certain minerals

These changes in ownership laws can have a signifi cant impact on

the reward miners’ expect to receive for the risk they have taken

When partial divestment is done part way through a mine life, the

mining company has paid for 100% of the investment, including the

upfront exploration, development, commissioning and early

operating risk, but will be giving up a percentage of the future

investment return That can be the equivalent of a very high tax

Even if they can sell shares to locals, the value of those shares will

likely be at a reduced market value as fewer buyers can afford an

interest so they may have to sell down ownership at a loss There is

an increased need for project economics and modelling before any

investment is undertaken to factor in the probability of changes in

policy, e.g., how will forecast returns be affected if there is a 40%

chance the mining and metals company has to sell 49% of its

shareholding at a loss?

Capital, risk/reward ratio and the sell decision

The increasing spread of resource nationalism has an effect on

where mining and metals companies invest their capital Mining and

metals companies are weighing up the risk-reward ratio and will

take into account any potential policy changes when modelling the

economics of any future projects In the 2012 Capital Confi dence

Barometer survey undertaken by Ernst & Young, almost two-thirds

of surveyed senior mining and metals industry executives indicated

that they will invest in organic growth over the next twelve months

This means they will be looking to invest capital in new, greenfi eld

sites or in expanding existing operations In either case, they will

have a choice on the location of that investment and recent or proposed changes in tax regimes will impact those choices The hurdle rates for those investments will have to take into account the higher risk associated with resource nationalism

Mining and metals companies will also be considering the impact of resource nationalism on their existing projects Changes to the mining laws or tax regimes will lead to a re-evaluation of a mining and metals company’s operations New taxes or the prospect of new levies will weigh into whether the company divests its interest or sells down to maximize its investment return

Mining and metals companies should evaluate current operations just as they evaluate new investments and the risk reward ratios have changed in those jurisdictions where resource nationalism is occurring or trending Companies will be working this into their life

of mine models

The average global risk has increased for investment so the related reward must be higher in order to make the requisite investment Mining and metals companies will make choices for future and current investments across projects and countries based on the expected returns as risk adjusted Those governments which increase their take will lower the returns and increase the risk for mining and metals companies, and will jeopardize future foreign direct investment

Broader economic impact of mining investment

Governments are currently seeking a higher return on their natural endowment but should consider a broader view of the return from natural resource development Governments will not only realize royalties and direct mining taxes from the natural resource as it is developed, but will also realize income taxes and other taxes such

as VAT on purchases of equipment and other property, ad valorem

taxes and payroll taxes In addition, mining activities provide direct mining jobs and indirect jobs through infrastructure development and suppliers, and the associated income and payroll tax revenue from those jobs Hence, there is often a signifi cant ‘multiplier effect’ associated with the development of new mines

Product of consultation

In many resource-rich countries, the capital investment can be

signifi cant For example, in Peru, the Government is forecasting

investment into its mining sector of US$53b over the next fi ve

years.3 As previously mentioned, a recent change of regime in Peru

led to an increase in tax on mining operations In anticipation of the

regime change, organizations in Peru met with the new

Government, presented comparisons of the ‘government take’ in

alternative mining and metals locations, and discussed a range of

options to enhance tax revenues from the current and future

operations in Peru The new levies were based on net income from

the sector and there was recognition that new revenues were

needed In addition, many of the big mining and metals companies

in Peru have agreed to pay additional taxes over that agreed in

their stability tax agreements, as long as they are not

unreasonably high.4

The inevitability of increased government take during a super-cycle

has led mining and metals companies to move from outright

opposition to changes in fi scal terms, to negotiating offsets This

has been because the political weight behind an increased take has

been increasing but value restoring trade-offs are politically

achievable Some of these offsets include:

• A more effi cient (profi t based) taxation system

• Removal of ineffi cient taxes

• Speeding up the development approval process

• Improving fl exibility of labor

3 Peru dangles its investment credentials, MiningnewsPremium, 23 May 2012

4 Peruvian miners brace for tax news, Financial Times, 25 August 2011

Mining and metals companies are looking at the government consultation process as a means of preserving value as opposed to just defending fi scal terms

Corporate governance

Resource nationalism and political changes in resource-rich countries creates further unpredictability for organizations investing in long-term projects There will be increased political uncertainty in determining project economics, which increases the overall cost of doing business and the related risk In addition, political changes have an effect on contract stability and often this

is not just a one-off event Countries can make a series of changes

to their mining laws over a number of years

As a result, the decisions about investments have become riskier, which will require greater involvement by the board in tax matters

and tax planning In 2009, the Ernst & Young Mining and Metals Tax Survey found that only 65% of tax directors presented periodically

at the board level We predict that with the increase in resource nationalism, tax directors will be getting more airtime with the boards of their companies, which will need to increase their focus

on tax considerations and implications on risk

Steps mining and metals companies can take to respond to this risk:

• Invest in transparent relationships with host governments to

foster a greater understanding of the value of the project to

the host

• Align with the host government’s long-term economic and

political incentives and thereby become an invaluable part of

the infrastructure in the host country

• Focus on generating direct and sustainable benefi ts for the host

community through pro-active and well organized social and

community development programs

• Align with multi-lateral agencies, such as the World Bank, to achieve a ‘prominent victim’ status in the face of mounting resource nationalism

• Partner with state owned enterprises that have strong Government-to-Government relationships

• Encourage direct government participation

“With the massive increase in resource nationalism, comes an increased need for tax directors to be

more involved in strategic risk decisions.”

Andy Miller

Global Mining & Metals Tax Leader, Ernst & Young

Skills shortage

(same as 2011)

Identifying, attracting and retaining critical operational and

construction skills remains a top priority for the mining and

metals sector in 2012 Continued sector growth with 136 new

projects planned or announced in the 2012 calendar year 1 once

again magnifi es and escalates the problem However, the outlook

on investment is cautious, with companies prioritizing and

sequencing investment in projects, thus impacting skills

demand-and-supply dynamics The scaling back or shelving of several

large projects during the year may provide some temporary relief

from the skills shortage However, in this volatile environment,

it is increasingly diffi cult to forecast and plan future workforce

requirements, and this is why skills shortage remains the second

most critical risk in the mining and metals sector

The risks associated with skills shortages are signifi cant:

1 Impact to production output — there is a risk that insuffi cient

skills may limit current and/or planned output According to BHP

Billiton, Australia’s resources industry needs an extra 170,000

workers in the next fi ve years.2 In Canada, the Mining Industry

Human Resources Council’s 2010 National Employer Survey

reported that 40% of the Canadian mining workforce will be

eligible for retirement by 2014, taking with them an average of

21 years of mining sector experience each, and driving the need

for skilled workers to 60,000–90,000 by 2017.3

2 Delay, downsizing or cancellation of projects — the shortages in

both skilled and unskilled labor contribute to project delays, the

impact of which is felt by both mining and metals companies and

contractors Meeting contractual obligations will be diffi cult, and

the viability of projects will also be impacted as there is not

enough labor to successfully implement the number of planned

projects In Canada alone, operations in 32 Canadian mines were

either suspended or shelved during 2009–2011.4 Even the

larger mining and metals companies are experiencing the impact

of the skills shortage, e.g., rising skills costs was one of the

contributing factors that led to Newmont Mining writing off the

Hope Bay gold project.5

1 Raw Material Group

2 Australian mining giant BHP Billiton estimates that the industry will need a further , Federal

Government Broadcast Alerts, 3 October 2011, via Factiva © 2011 Media Monitors Australia Pty Ltd.

3 http://magazine.mining.com/issues/1005/PDFWeb.pdf

4 Canadian Mining Industry Employment and Hiring Forecasts, 2011

5 Newmont puts Hope Bay gold project on hold, http://www.cbc.ca/news/canada/north/

story/2012/02/01/north-newmont-hope-bay.html, accessed 17 May 2012; Newmont Mining posts

4Q loss on project writedown, http://fi

nance.yahoo.com/news/Newmont-Mining-posts-4Q-loss-apf-4285689275.html, accessed 17 May 2012

3 Global mobility — the current labor shortage within the mining

and metals sector necessitates a global approach to mitigate the risk as there are often insuffi cient numbers and/or skills available

in the local market Therefore, being able to attract and mobilize key talent globally in a cost effective and effi cient way, whilst ensuring compliance with local immigration and tax regulations, becomes a critical requirement This, however, does not always receive local community and government support, and in some cases government policies and requirements may in fact restrict the ability to access and move talent globally

4 Increasing labor costs — competition for scarce labor increases

employment costs and erodes production margins In addition to varying commodity prices, companies now have to contend with

an increasing cost base According to Jac Nasser, Chairman of BHP Billiton, the cost of doing business in Australia is increasing due largely to higher wages in the country The resource projects

in Australia cost around 40% more than the cost of a similar project in the US Gulf Coast.6

Companies that are able to plan ahead are using a number of strategies to deal with skills shortages; both short and long term Some of the more innovative approaches we are observing are

as follows:

1 Differentiated employee value propositions

In this competitive labor market, talented employees have choices, and therefore companies must differentiate themselves from their competitors by developing compelling offers to attract and retain the best talent Ernst & Young’s work developing employee value propositions for mining and metals companies clearly shows that remuneration and career opportunity are rated as equally important by employees and that there are a range of other factors that infl uence their employment decision

6 Nasser’s defence is all-out attack, The Age, 17 May 2012, via Factiva © 2012 Copyright John

Fairfax Holdings Limited

“There is no easy fi x to the skills shortage issue, but being creative and fl exible in your approach can

open up new pools of talent.”

c Individually tailored

Set remuneration at competitive

but not inflationary levels

across workforce segments

Companies need to understand what is important to their

targeted workforce and be creative in providing not only an

attractive compensation but also a range of additional employee

benefi ts In order to retain employees, companies need to

engage with them at multiple levels7 and clearly communicate

the full range of benefi ts of employment with their company

a Attractive compensation

Companies are becoming increasingly focused on employee

related costs Remuneration arrangements are being

reviewed and rebalanced to ensure they are fair and

competitive for the individual, while being affordable and

sustainable for the organization In addition to taking a more

targeted approach to compensation design and provision,

companies are focusing on enhancing their employees’

understanding of the remuneration arrangements on offer,

and the purpose for which each remuneration element is

being provided

b Non-fi nancial benefi ts

Companies are also employing a range of non-fi nancial

benefi ts and arrangements to assist with workforce

recruitment, engagement and retention One of these is

fl exible work schedules to enable employees to have a

positive work-life balance while ensuring operational

requirements are achieved This is especially prevalent in the

development of FIFO/DIDO rosters To provide greater

balance of time in home location with time on site, rosters

7 Attracting workers to the mines and retaining them, Ernst & Young, 2008

have evolved over recent years from 2 weeks on 1 week off to

9 days on 5 days off, to 8 days on 6 days off, and now to a 8/6/7/7 rotating roster. 8 In addition, companies are also providing additional fl exibility such as career breaks, working from home, the ability to work part-time and parenting leave options as a means of attracting and retaining talented employees Other benefi ts that are typically being offered include relocation assistance, in-house and online education alternatives for career development, and free or subsidized childcare facilities

c Individually tailored employee experiences

In addition, mining and metals companies are tailoring their attraction and retention strategy so that they are aligned to employees’ geographic location, nationality and life stage who may have different needs and expectations Greater

sophistication in profi ling the market will better enable Human Resource Directors to respond to the threat that labor shortages pose to their company’s competiveness Leading organizations are utilizing predictive modeling techniques to tailor their offerings to target different labor segments and better match job roles with candidate preferences A key trend emerging is the increased importance both candidates and employees place on career development and progression

as a driver of attraction and retention Nowhere is this more pertinent than in the mining and metals sector where a lack of clear career pathway and opportunities are often cited as a reason for leaving.9

8 8/6;7/7: Example of rotating roster where working 8 days on/6 days off and 7 nights on/7 nights off

9 Career and life survey, Ernst & Young

Steps companies can take to respond to this risk:

• Source skills from aligned sectors and a broader demographic

• Account for demographic and diversity factors when making

investment decisions

• Initiate programs that encourage semi-skilled and retired

workers to re-enter the work-force

• Target initiatives to retain critical skills held by older workers

• Develop strategic alliances with institutions and communities

• Target initiatives to optimize productivity

• Substitute capital for labor through innovation

Steps mining and metals companies can take to respond to this risk:

Five things that leading companies do well when attracting and retaining staff

1 Get the employment offer right and effectively communicate

and reinforce it

2 Develop effective career pathways and well-aligned employee

development programs

3 Build internal capability to effectively manage people

4 Understand employee needs and the markets in which they reside for effective workforce planning

5 Execute well across attraction and recruitment, and development and progression

2 Accessing non-traditional and under-represented labor pools

Women and indigenous workers are two signifi cant talent pools

that are not yet fully leveraged by the sector Further, there are

skills and experience in other sectors which could be effectively

leveraged into mining and metals organizations With policies

and practices catered to address the needs and requirements of

these specifi c groups, the sector could potentially increase the

available talent pool

Indigenous engagement is crucial since indigenous communities

represent a large source of labor close to mining and metals

operations, and are often one of the fastest-growing

employment pools in the country To utilize this resource pool,

many companies have set a minimum target to employ

indigenous workforce at mine sites, and governments are

implementing incentive programs for these communities to gain

the appropriate skills to enter mining-related employment, e.g.,

the Canadian Indigenous Skills and Employment Partnership.10

This benefi ts not only the indigenous communities, but also

contributes to the companies’ social license to operate

The effective participation of women in the sector is currently

low — in Australia, women represent only 18% of the workforce in

mining, as opposed to 45% of the total workforce,11 and in

Canada, 14% of the mining labor force, as opposed to the

country’s average participation rate of 47%.12 The participation

of women in the sector is often limited due to issues such as the

lack of part-time work in the sector, a culture of long hours,

10 Attracting workers to the mines and retaining them, Ernst & Young, 2008

11 Attracting workers to the mines and retaining them, Ernst & Young, 2008

12 Canadian Mining Industry Employment and Hiring Forecasts 2010, Mining Industry Human

in mining includes tax deductibility of work-related child care expenses, fringe benefi ts tax removed from employer sponsored childcare, and education programs aimed at employers to inform

on gender equity, amongst others.13

3 Sourcing workers from other sectors

The shortage of mining and metals skills has prompted some companies to consider resources in other sectors with similar and/or complementary skills, such as oil and gas, engineering, construction and manufacturing Targeting resources in these sectors has created a widening resource pool of both technical (e.g., electrical trades, fi tters and turners) and professional (e.g., civil and mechanical engineers) skills Further, the relative growth

of mining and metals versus other sectors may also provide more immediate access to resources due to slowing down and

contraction within these other sectors For example, in August

2011, BHP Billiton established an online portal to take applications from the 800 workers affected by a company’s decision to cut jobs in Illawarra, Australia In the wake of the US$9.5b capital expenditure plan, BHP Biliiton is hiring from allied sectors for its operations in Illawarra, Queensland and Western Australia.14

13 Gender pay equity and associated issues for women in mining — Survey Report, The AusIMM,

http://www.ausimm.com.au/content/docs/gender_pay_equity_wim_report.pdf, accessed 24 May 2012

14 Sacked steel workers wanted in WA, Australian Broadcasting Corporation (ABC) News, 24 August

2011, via Factiva © 2011 Dow Jones & Company, Inc.

Infrastructure access

(same as 2011)

While prices have moderated over the past year, they remain

above historical averages driven by economic growth in the

rapidly developing economies This continues to challenge the

mining and metals sector with its supply response The need

to expand existing production or develop stranded deposits

is keeping infrastructure access in the top three sector risks

Indeed, global mining capital expenditure is expected to grow 14%

in calendar year 2012 This is being driven by a range of mining

development projects in developed economies like Australia

and emerging markets of China, and Africa 1 Resources sector

investors from countries like China, Japan, Korea and India have

emerged as new infrastructure sector investors in the last few

years, in addition to traditional funding from OECD countries

For example, Japanese fi rm Mitsubishi Corp is championing the

Oakajee Port and Rail development in Australia 2 and Chalco

and Rio Tinto are developing the Simandou iron ore project in

Guinea, Africa 3

One of the clear impacts of the long running minerals boom has

been that resource deposits long classed as marginal or

uneconomical have gradually become more viable Typically these

deposits have been of lower quality or remote from existing supply

chains and thus the lack of suffi cient infrastructure, either logistics

or secondary processing, has been the primary obstacle to rapid

development of these resources Speed is seen as essential in

developing these deposits as there are only so many of these

standard assets that will be developed Remoteness naturally brings

additional challenges in terms of cost, risk and scale of development

of the required transport, utilities and supporting infrastructure We

see a real divide in the approaches of individual organizations:

• The tier one mining and metals organizations have the balance

sheet strength to proceed with integrated mine/logistics

developments but are under shareholder pressure to restrict new

capital expenditure

• The smaller mining and metals oganizations struggle to fund

large sole use infrastructure developments

1 The global mining machinery handbook, 14 March 2012, Morgan Stanley

2 http://www.opandr.com/, accessed on 20 June 2012

3 Chinalco sets up consortium to develop Simandou iron ore project,

• Collaborate with similar sized competitors or larger off-take customers to jointly develop the required infrastructure For example, Sundance Resources, which is developing the Mbalam iron ore project in West Africa, is collaborating with regional iron ore developers Core Mining and Equatorial Resources to develop the infrastructure, and is also the subject of a takeover offer by Hanlong Mining, a Chinese company4

• Where competition regimes exist, seek access to the existing privately developed networks (the Pilbara iron ore rail network access dispute between iron ore miners in Western Australia is an example of this process)5

A key issue in structuring transactions for pivotal supply chain infrastructure is control: control over the operational protocols and expansion profi le gives an organization a signifi cant advantage over its competitors in setting the speed with which product is delivered

to the market Negotiations over joint development agreements and third party access terms are typically long and complex as the control issue is dealt with Anketell Port in Western Australia and the Wiggins Island Rail expansion in Queenland, Australia are both examples where negotiations on control have been extensive and have delayed the fi nalization of project delivery Our view is that a signifi cant portion of the synergistic value that would be generated

in a more cooperative approach is being lost

4 Sundance Resources regulatory fi lings to Australian Stock Exchange in 2011 and 2012

5 Rio Tinto completes formation of Simandou joint venture with Chalco, Rio Tinto press

release, 25 April 2012

We expect the key infl uences on the fi nancing of infrastructure

to be:

1 The changing role of government

The role government plays in infrastructure development continues

to evolve We are seeing three trends emerge:

• Reduction of direct government funding allocated to the

development of supporting infrastructure driven by global

pressure on government budgetary positions

• Increased pro-activity from governments in the planning and

approval processes to both enhance the effi cient development of

the necessary infrastructure (avoiding wasteful duplication of

supply chains), and to preserve effective competition for valuable

rail and port rights In the developing nations, the focus is

typically on the fi rst of these issues

• Provision of incentives for the private sector to fi nance and

provide necessary infrastructure either through tax incentives,

orderly risk transfer, or project approvals

2 Increasing infl uence of foreign customers

We are observing a continued infl uence of Chinese, Indian and

Korean investors in infrastructure development These companies

tend to have government backing (in terms of funding and strategy)

and tend to deal directly with local governments They look to

partner with junior mining and metals companies and local

government in developing projects and it is common for them seek

pit to port control and off-take commitments in return for otherwise

unavailable debt and equity funding Junior mining and metals

organizations, while apprehensive over surrendering logistics

control, typically have few other viable funding options and thus

there is substantial fi nancial pressure to agree to accept those

terms and conditions

3 New sources of infrastructure funding from institutional

investors

Pension, sovereign wealth and infrastructure funds have emerged

as a new source of funding, with a preference to fund projects

where there is limited un-pooled commodity risk Pension investors

are extremely reluctant to take raw usage risk These investors will

typically require material greenfi eld or brownfi eld expansions to be

supported by take or pay contracts from a bankable mix of mining

and metals organizations to be attractive We note that third party

fi nancial investors do not benefi t directly from the synergies that

accrue to producers for control of the supply chain and thus may

require a yield premium This further reduces the viability of

projects, and biases against resource developments without solid logistics infrastructure or sponsored by tier one organizations Mining and metals companies are increasingly looking at partnerships to provide additional funding sources Whilst these models can introduce a broad range of additional risks, increase the complexity of the process and include additional development challenges, in some cases they can provide a viable alternative

4 Financing market challenges and ongoing volatility

The global fi nancial crisis of 2008 resulted in increased debt pricing, tightening of lending covenants, reduced lending tenors and a signifi cant contraction amount of bank debt available to

fi nance infrastructure projects There has been a consequent adjustment in the banks participating in the infrastructure project

fi nancing market The impact of the departure of a number of well known European banks from this market has been partially offset

by increased participation from Asian and Canadian based lenders However, for a robust project with an appropriate commercial structure, debt funding remains a viable funding option as shown

in the Wiggins Island Port project in Queensland, Australia The current volatility in fi nancial markets and also the upcoming introduction of Basel III means the current challenges for non-recourse project fi nance structures to secure funding are likely

to continue

5 Increased focus on corporate governance

Boards are placing greater scrutiny on where their investment dollars are spent This is being driven to some degree by the poor condition of the global funding markets and the consequent limitations on the terms, availability and pricing of capital This has triggered further internal competition for investment capital between business units Boards are thus focusing on projects with lower risk and capital usage profi les Projects with substantial infrastructure development tasks have higher capital requirements and tend to face lower overall returns This means, in some instances, projects are being delayed in order to ensure more robust analysis, justifi cation and scope rationalization prior to receiving approval In addition, we are seeing signifi cant changes in the relative cost of developing projects — reduced productivity, changing sovereign risk profi les and the level of competition for skilled labor and materials are all impacting on the viability and priority of projects across the globe The Minerals Council of Australia recently cited that “low productivity growth and rising cost structures in Australia have contributed to deteriorating international competitiveness over recent years.”6

6 Boom under threat from higher costs, Australian Financial Review, 30 May 2012

“Changing market conditions will force resource producers to amend infrastructure development plans

Given the softening commodity prices, the cost curve will play a more critical role in determining which

projects will proceed and most importantly when they will be developed ”

Neal Johnston

Partner, Infrastructure Advisory, Ernst & Young Oceania

Steps mining and metals companies can take to respond to this risk:

• Consider the extent to which infrastructure defi cits may impact

on enterprise value

• Understand the return on all capital expenditure, including

infrastructure, and consider appropriate fi nancing

• Look for other stakeholders to co-develop a solution with shared

benefi ts

• Investigate partnerships with other potential stakeholders in expanded infrastructure to innovate fi nancial arrangements including off-take

• Improve mine planning to assist in assurance over optimal levels

of take-or-pay commitments

Outlook

Infrastructure blockages remain prevalent in rail and port

infrastructure supply chains and are increasingly impacting mine

supporting infrastructure and power and utilities networks due to

the remote development locations

The current uncertainty over global fi nancial markets has added

additional risk to the process of pit to port mine development A

downward trend in resource prices would force an immediate

reassessment of marginally economic deposits, so the need for

rapid development while the price environment remains benign is a

key concern for all mining and metals organizations The task then

is unlocking the value of co-ordination and collaboration between

organizations so that the full infrastructure cost profi le is effi ciently

allocated and funded

With governments less able to fund supply chain infrastructure as it has in the past, a new paradigm has formed whereby the private sector needs to play this role This necessitates changes to the procurement processes and risk allocation between government, users, developers and funders For this to be effective, traditional views around construction risk, residual value, revenue/pricing risk, capacity, operational control, credit risk and tax need to be re-assessed Unless the commercial risks can be adequately addressed and the take or pay contracts bankable, then development of infrastructure will continue to be slower and more complicated than would appear necessary

(Up from 8 in 2011)

04

Cost infl ation*

Over the past decade as the sector and its suppliers have

struggled to increase supply, cost infl ation has re-emerged

as a major risk for mining and metals companies globally It is

estimated that the sector experienced cost infl ation of between

10% and 15% in 2011, with overall cost infl ation averaging

roughly 5–7% in the last 10 years (this equates to a doubling

of costs every 10–14 years) 1 Cost infl ation in the industry is

expected to intensify over the next several years due to a number

of factors, including labor, energy, ore grades, and taxes.

Subdued demand and low commodity prices, while costs

continue to rise

According to Rio Tinto CEO Tom Albanese, softening commodity

prices, higher input costs, and soaring Australian and Canadian

dollars are pressuring margins.2 Corroborating this view, several

mining and metals organizations have cited the twin evils of rising

costs and lower commodity prices as the main causes for recent

declines in profi ts Take for example aluminium and nickel

producers — these commodities have witnessed the most signifi cant

drop in prices since August 2011, and given their nature, are

known to incur very high operating costs:

• UC Rusal reported a 91.7% drop in net profi t for 2011 due to

rising costs and lower prices, with aluminium trading near its

marginal cost production3

• Alcoa recorded a loss from continuing operations of US$193m in

4Q11 In 1Q12, the aluminium producer reported a 70% y-o-y

drop in income from continuing operations to US$94m4

• BHP Billiton’s Stainless Steel Materials (nickel) business reported

a 99.7% y-o-y drop in earnings before interest and taxes for the

half year ended 31 December 2011,5 partially a refl ection of a

35% drop in nickel prices through 2011

• In 1Q12, Vale’s nickel unit reported a 29% y-o-y decline in

operating revenue due to low nickel prices6

* Renamed from ‘Cost management’ in 2011 as it better refl ects the infl ationary environment

1 Cost infl ation is major theme for metals production: Deutche Bank, Commodity

Online, 16 April 2012

2 Commodity prices spark Rio Tinto warning, Australian Broadcasting Corporation (ABC)

News, 28 November 2011 via Factiva (c) 2011 Australian Broadcasting Corporation

3 More pain looms for aluminium, The Australian Financial Review, 13 January 2012

4 1st Quarter Earnings Conference, Alcoa Quarterly Earnings Presentations, 10 April 2012

5 BHP Billiton Results for the Half Year Ended 31 December, BHP Billiton press

release, 8 February 2012

6 Performance of Vale in 1Q12, Vale fi nancial performance, 25 April 2012

Companies revisit robust capital expenditure plans

The period of record-high commodity prices extended from 2H10 to 1H11, masking the real impact of rising costs, as the mining and metals sector enjoyed large profi ts During this period, mining and metals organizations implemented signifi cant capital investment plans and also increased production to cash in on the period of premium pricing As a result, the supply of raw material, labor and equipment to the industry has tightened considerably, pushing up operating and capital costs alike

In early May 2012, AngloGold Ashanti approved capital investment for the Kibali gold mine in the Democratic Republic of Congo (DRC), which it is developing with project partner Randgold Resources Total capital expenditure for the project (including contingencies) has increased to US$2.2b versus the 2010 feasibility study estimate of US$1.4b Though Kibali’s mine design and mine schedule has been optimized since the original 2010 feasibility study, this 55% increase in capital expenditure highlights rampant capital cost infl ation across the mining and metals sector.7Capital cost infl ation without a concurrent increase in underlying commodity prices is forcing industry players to revise their capital expenditure targets Large and small scale players, irrespective of commodity, are succumbing to capital cost pressures and this is likely to result in delays to new supply across all sectors within the industry This slowing of the supply response may help sustain above average pricing and thereby attract more development

Crude oil prices, wage infl ation and increasing complexity drive operating costs

Operating costs continue to increase on the back of high crude oil prices and wage infl ation The cost of mining consumables and transport is closely linked to the price of oil, which has been on the rise since 2010 Oil prices continue to trade at around US$100/barrel, and rising tensions between Iran and the Western economies, together with supply concerns in Africa, present major risks to oil prices in the medium term Wage infl ation is also rife across the sector, as employees seek to share the profi ts Several mines across the world were hit by labor strikes for higher pay in 2011, triggered

by the record-high commodity prices and near-record profi ts that sector players experienced between 2H10 and 1H11

7 AngloGold Ashanti Q1 Earnings Double to US$429m; Approves US$1.9bn Growth Projects,

Marketwire, 10 May 2012

Operating environments for mining and metals companies are

becoming more complex, posing both physical challenges (deeper

underground mining, remote locations etc.) and political challenges

(safety concerns, regime instability etc.) More complex operations

generally mean more costly operations While physical challenges

can be addressed by investing in expensive new technology and

infrastructure, political challenges bring with them increased and

constantly changing safety and environmental reporting, causing a

substantial increase in compliance costs

Declining ore grades and consequently higher production costs are

a reality that several existing mines are struggling with globally

Similarly, miners are going deeper underground as higher prices

allow — a costly affair in comparison to traditional open pit mining

So although the profi ts are there, the same margin is not being

realized

Mining and metals companies are increasingly investing in new

regions as desirable mining projects become harder to fi nd

However, much of this potential new supply is located in remote

areas — a physical challenge that translates into even higher costs

than the general levels the industry is facing:

• Consumables — due to the lack of access to national power grids,

many remotely-located projects are forced to rely on diesel

generators to power their operations Agnico-Eagle Mines’

Meadowbank mine in Nunavut (Canada) uses up to 60m liters of

diesel annually, making energy one of its biggest cost pressures8

• Labor — mines located in remote areas struggle to hire and retain

skilled staff, with labor often cited by CEOs as a top cost pressure

In order to attract and retain skilled labor to remote locations,

companies are forced to pay increasingly competitive salaries and

rely on fl y-in fl y-out labor pools

• Lack of infrastructure — the lack of roads, rail, power, water and

other infrastructure adds to the development costs of mine

projects in remote areas Additionally, costs specifi c to social

infrastructure are increasing

8 Canada’s Nunavut awaits its day in the sun, Reuters News, 2 April 2012

The increasing costs and falling revenues of remotely-located projects are threatening to make them unviable For example, a

signifi cant number of upcoming and operating gold projects in

Canada’s Far North region have been written-down partially or shelved altogether for this reason Growth strategies are increasingly shunning the additional cost burdens of developing greenfi eld projects in favor of brownfi eld expansions at exiting sites where manpower, resources and infrastructure are already in place

The currency impact

Industry-wide cost infl ation is being compounded by strong currencies in most resource-rich countries Since late 2008, the Australian dollar has strengthened by over 60% against the US dollar; the currency global commodities tend to be priced in The Canadian dollar, Chilean peso, Brazilian real and South African rand have all moved similarly This has pushed up the relative cost of wages, power and other local goods in these countries

How is the industry responding?

Cost infl ation, in a period of softer commodity prices, is forcing mining and metals companies to either re-evaluate, shutdown or divest high cost and non-core business units Several companies are reviewing their portfolios to identify underperforming assets Energy-intensive aluminium is already witnessing multiple shutdowns and closures in the industry A number of companies are opting to divest their downstream aluminium assets where China has excess capacity, while retaining upstream assets where demand, particularly from China, is expected to remain strong Aluminium major Alcoa has closed substantial volumes of smelter capacity, while Rio Tinto is divesting parts of its aluminium business.9 There has also been re-evaluation in the nickel sector, with BHP Billiton cutting production and Kagara Mining entering voluntary administration.10

9 Rio Tinto to divest US$8bn of aluminium assets, The Financial Times, 17 October 2011; Alcoa Sees

Aluminum Cuts as Production Gains: Commodities, Bloomberg, 10 April 2012

10 Western Areas buys Kagara nickel mine, The Australian, 2 March 2012; BHP to make fi rst job cuts

since GFC as nickel dives, The Australian, 2 February 2012

“Cost infl ation is a risk that keeps growing, and continues to threaten profi t margins and the viability

of projects.”

Paul Mitchell

Global Mining & Metals Advisory Leader, Ernst & Young

Rising costs are also driving consolidation within the industry for

synergies, economies of scale and greater negotiating power

Larger companies tend to be in a stronger position to negotiate

better terms with contractors and suppliers Interestingly, some

sector players are beginning to forge collaborative relationships

with their contractors and suppliers, with the aim to achieve greater

savings and increased productivity For example, to identify

opportunities for waste removal from the supply chain, Vale’s

procurement team holds collaborative workshops not only with

other functions within the company, but also with suppliers Vale’s

“collaborate to innovate” workshops have helped save costs worth

roughly US$500m over a span of just three years.11 The category

management approach is also gaining popularity with procurement

teams, whereby the relationship between a miner and its suppliers

moves to one of collaboration, rather than the traditional

adversarial relationship Such an approach generally entails the

exchange of information, sharing of data and joint business

building, with common turnover, profi tability and cost-saving

targets that mutually benefi t the miner and supplier/contractor

Companies are increasingly turning to technological solutions to

mitigate wage infl ation The high cost of supporting a fl y-in fl y-out

workforce is pushing companies to invest in automation Rio Tinto is

11 Procurement Teams Recognized for Innovation, MyPurchasingCenter.com, 28 September 2011

committed to this solution with plans to spend US$483m to make its trains driverless, a decision that follows last year’s move to put

150 automated dump trucks into its Pilbara mines in Australia The company’s automated production drills, loaders and haul trucks will

be supervised from a remote operations center in Perth Rio Tinto could save an estimated US$72m per annum, cut its workforce by

600 and reduce costs by 30 cents per tonne of iron ore if 50% of its trucks are automated.12 Fortescue Metals Group and BHP Billiton are also moving in the direction of driverless truck technology Companies are also focused on reducing energy-related costs by investing in energy projects and even taking interests in power assets Furthermore, capital cost overruns have highlighted the need for more robust systems to improve forecasts and project controls To lower their cost base, companies are increasingly procuring equipment from developing countries A switch to owner-operated mines could also help companies save costs BHP Billiton has acquired part of Leighton Holdings’ HWE Mining division

to bring its Pilbara iron ore operations inhouse rather than hire outside contractors Discounting estimated contractor margins of 5% to 7%, the miner’s cost base in the Pilbara will reduce by roughly US$55m to US$77m per annum (60–90 cents per tonne of iron ore).13

12 Rio high in an empty driver seat, The Age, 6 April 2012

13 BHP turns owner-operator in US$735m buy, The Australian Financial Review, 10 August 2011;

Completion of the Acquisition of HWE Mining, BHP Billiton press release, 30 September 2011

Steps companies can take to respond to this risk:

• Focus on sustainable cost reduction programs

• Divestment in non-core assets

• Review of capital tied up in high levels of pre-stripping, advance

development and stockpiles

• Consideration of the use of contract mining vs sale or leaseback

• Review of supplier contracts

The current period is shaping as a time of great opportunity,

and great challenge, for mining and metals companies delivering

major capital investment pipelines A massive pipeline of

committed projects requires delivery during the 2012–2015

period Competition for resources to execute remains as acute

as ever Announced investments across the global mining and

metals sector totalled US$676b at the end of 2011 — an immense

20% y-o-y rise 1 Mining and metals leaders are increasingly aware

of global macro-economic trends and are actively shaping their

delivery strategies accordingly

These trends stem from heightened global economic volatility and

continuing delivery cost infl ation:

• Uncertainty around the rate of growth in demand for metals and

energy from the ‘growth engine’ economies

• Uncertainty as to the price for key commodities, impacting

economic hurdle rates for capital investments

• Uncertainty as to regulatory obligations impacting environmental,

labor and taxation requirements

• Increasing delivery costs resulting in frequent and substantial

cost variances on recent capital projects

This uncertainty has been putting downward pressure on prices of

mined commodities since 2H11 and has placed emphasis on the

increased need for effi cient project selection, planning and

execution to ensure good returns in times when margins are

already under pressure Established producers have a vested

interest in moderating the supply response during a period of

premium commodity pricing for as long as possible rather than

supplying sooner but eroding their premium

1 E&MJ’s Annual Survey of Global Mining Investment, 20 Jan 2012, www.e-mj.com

05

Capital project execution

Commodity price trend

In view of the volatile macroeconomic environment, not only have the new project announcements slowed in 2012, but mining and metals companies are now reconsidering, revising and prioritizing

or sequencing previously announced capital project plans About 47% of the mining and metals companies polled by Citigroup during 1Q12 are considering lowering their capital expenditure budgets, compared with 18% that were considering lowering their budget in 4Q11.2 Companies are now exercising caution in laying out capital expenditure plans:

• BHP Billiton is reportedly revisiting the sequence of its capital expenditure plans to maximize value and reduce risk as it faces the prospect of lower cash-fl ow generation from its projects While the company is expected to reach a decision on several major projects including Olympic Dam and Port Hedland in Australia by the end of 2012, it is now unlikely that it will spend the reported US$80b in capital expenditure by 20163

• Rio Tinto has announced that it is carefully evaluating projects and that some growth opportunities may not be developed4

• Vale’s overall budget for capital expenditures on project execution for 2012 is 12.9b, compared to US$17.5b in 2011 In view of the risks associated with the execution of projects, the company has said that it may revise the estimates of their projects’ expected capital expenditures and estimated start-up dates5

2 Signs of Fatigue in the Commodities ‘Supercycle’, The Wall Street Journal, 23 May 2012

3 BHP Billiton pulls back from US$80bn spend,” The Telegraph, 16 May 2012; BHP moves to ease

worries over mega project spend, Reuters, 2 May 2012; BHP Billiton tweaking capex plans, CEO says,

http://www.marketwatch.com, 15 May 2012

4 Rio Tinto reaffi rms confi dence in demand outlook , http://www.marketwatch.com, 9 May 2011

5 Vale announces investment budget for 2012, Vale press release, www.vale.com

(same as 2011)

The metals and mining community adapts

Leading mining and metals companies are adapting to emerging

capital project risks by raising the bar on business case justifi cation,

prioritizing investment pipelines and enhancing the level of project

control expected of delivery teams

• Raising the bar on business case justifi cation and rigor

Business cases are made or broken on the back of estimated

costs and benefi ts and there is now a renewed focus on the

integrity of this data Projects are being asked to declare

transparent estimation methodologies, benchmark against

historical performance and stress-test their numbers for a range

of anticipated delivery scenarios Improved rigor in underlying

business case data substantially improves management’s level of

decision-making confi dence

Every project faces a unique array of delivery risks but not every

business case factors these in Project teams that holistically

assess and, in turn, align contingency allocations to each project’s

unique risk profi le are ensuring business cases accurately defi ne

the likely capital outlay required Clearly declaring underlying

assumptions and arranging peer review validation builds rigor in

business case planning A key assumption, and risk factor, is the

impact of price volatility — scenario modelling will identify the

critical price-points for future business case review

Every business case needs an owner who can vouch for,

champion and be accountable for the delivery of the identifi ed

benefi ts Companies that establish clear and single-point business

case ownership can align delivery performance with an

individual’s key performance indicators (KPIs) and a business

unit’s capacity and budget forecasts

• Prioritizing the investment pipeline to align with a changing

appetite for cost and cash exposure

Mining and metals companies are making the hard call to

prioritize their capital expenditure As leadership teams develop

customized criteria to sequence their project pipeline,

prioritization considerations extend beyond return on investment

(ROI) to include strategic alignment, cash fl ow exposure and

delivery complexity

The assessment of strategic alignment requires mining and metals companies to determine how mega-project investments align to the company’s long-term (often multi-decade) business plans It is on this planning horizon that a broad range of strategic considerations come into play, such as which projects:

• Will drive performance against key analyst measures such as US$/tonne, market share and reputational value?

• Will establish the growth option infrastructure to support business-building investments into the future?

• Will support the diversifi cation of risk, price and currency exposure?

• Are aligned to commodities that the company seeks to grow, stabilize or exit?

• Are aligned to the company’s view of core business whereby the owner’s team may be seen as an investment manager, construction manager and/or operator?

• Offer a superior value proposition to comparable acquisitions?

• Have access to high performing and cost effective suppliers to undertake design, fabrication and construction?

• Will best leverage technologies suited to cost-reducing engineering design, offshore module fabrication and access low cost construction labor?

The projects that pass these tests will typically be sound candidates to advance towards the front of the pipeline queue The assessment of cash fl ow exposure is particularly relevant as leaders adopt an increasingly conservative decision-making bias and seek to optimize liquidity While mega-projects will be brought forward on the merit of their individual business cases, many companies will have a diminished appetite for running multiple cash-intensive investments in parallel and some will seek to actively decelerate expenditure rates Increasingly, cash-intensive mega-projects will be advanced in series and projects with long ROI payback periods will face critical review

The assessment of delivery complexity considers alignment to existing company capacity, capability and proven technical solutions Innovation will continue to play a critical role in improving effi ciency and effectiveness; however, this will be balanced against the predictability of proven solutions Similarly, brownfi eld expansion projects (where there is proven cash fl ow from an existing asset and existing operational infrastructure), may be advanced in favor of greenfi eld development options