The Economics of Mining:
Is the Boom already becoming a Bust,
and are we prepared?
Ian Runge
[email protected]
57
Ingredients of Boom/Bust
• New Technology, or something that disrupts the (previous)
structure of production
Current Cycle: Chinese manufactured goods on world markets
© 2012 - Ian Runge
Ingredients of Boom/Bust
• New Technology, or something that disrupts the (previous)
structure of production
• Finance / Money
Hero (occasionally)
Villain (often)
Transmission mechanism (always)
Current Cycle: US sub-prime housing finance, money supply growth,
ill-disciplined finance and poorly regulated new financial
instruments, sale of securities around the world
© 2012 - Ian Runge
Ingredients of Boom/Bust
• New Technology, or something that disrupts the (previous)
structure of production
• Finance / Money
• Institutional Influences
The framework upon which economic activity is conducted
© 2012 - Ian Runge
© 2012 - Ian Runge
Chinese Exports and Imports since 2001
US$1,800b
US$1,600b
US$1,400b
Exports
Imports
US$1,200b
US$1,000b
US$800b
US$600b
US$400b
US$200b
US$0b
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
© 2012 - Ian Runge
US Money Supply Growth 2001-2006
If the total money supply is increasing by
8% per year, and the price of consumer
goods (65% of the economy) is increasing
by 2% per year, where is the rest of the
money going?
© 2012 - Ian Runge
Where are we in the [Global] Cycle?
• Real losses ... gone forever .
• Consumption Expenditures during mid-2000s higher than we
“really” wanted to make
• so ... consumption cut-back by this much to reflect real intertemporal valuation
• and ... savings (de-leveraging) to get inter-temporal valuation
back in balance
• Adjustment due to financial mis-allocation, as well as
changed structure of production
© 2012 - Ian Runge
Supply/Demand Curves ~ How Realistic?
Supply Curve
PRICE
Demand Curve
Quantity
© 2012 - Ian Runge
Iron Ore Pricing 2005 - 2012
© 2012 - Ian Runge
Example: Iron Ore Supply Cost Curve
Source: Global Iron Ore and Steel Forecast Conference, Mar-2012 / Paper: Citi Investment Research and Analysis
Supply/Demand Curves ~ How Realistic?
$250
Demand
$200
$150
Price
$100
Supply
$50
$0
Quantity
© 2012 - Ian Runge
Capturing Producer Surplus when Demand Outstrips Supply
$250
Demand
$200
$150
Additional Producer Surplus
Price
$100
Supply
$50
$0
Quantity
© 2012 - Ian Runge
Where we don’t want to be!
Price
Quantity
© 2012 - Ian Runge
Optimum Production in a Simpler World
$150
$140
$130
$ per unit of Production
Marginal Cost
$120
$110
$100
$90
Average Cost
$80
$70
$60
$50
$40
$30
0
10
20
30
40
50
60
70
Production (mtpa)
Source: Mine Planning and Equipment Selection Conference 2010
© 2012 - Ian Runge
Mining Projects vs Simple Projects
• Proprietary Inputs – your costs can be substantially different to
the costs of competitors
• Face distinct downward-sloping demand curve AT THE TIME OF
PROJECT COMMITMENT
• Costs of Information are significant and are endogenous to the
project
© 2012 - Ian Runge
Well managed mining enterprises seek to:
• start up a mine at a rate that is substantially less than the
optimum rate for that deposit
• Provide for options to change (Real Options) – particularly the
option to expand
• Capitalizing on the Real Option to expand ….. things that you
don’t know enough about now, but you know that, once you get
going you will know enough about
© 2012 - Ian Runge
Example: Typical Large Scale Mine Development
Source: Global Iron Ore and Steel Forecast Conference, Mar-2012 / Paper: Gindalbie Metals Limited
Example: Typical Large Scale Mine Development
•
Start at 10 mtpa (includes capital
for Port at 16 mtpa)
•
Low Cost Expansion to 16 mtpa
•
Potential for 30 mtpa
Source: Global Iron Ore and Steel Forecast Conference, Mar-2012 / Paper: Gindalbie Metals Limited
•
Production: 8 mtpa
•
Low Cost Expansion to 10 mtpa
(only additional capital is for mining
equipment)
•
Resource life 60 years
•
Total Capital: US$4.2 billion
© 2012 - Ian Runge
Capital and Operating Costs – Large Coal Mine
$250/t
Coking Coal Price Range
$200/t
$150/t
Operating Costs
$100/t
Operating Costs
$50/t
Equiv. Capital
Costs
Equiv. Capital
Costs
$0/t
Average Costs
Marginal Cost
© 2012 - Ian Runge
Capital and Operating Costs – Large Coal Mine
$260
$240
Selling Price Range $205/t to $240/t
Cost of Production ($/t)
$220
$200
$180
Average
Cost Curve
$160
Base
Case
$140
Marginal Cost Curve
$120
$100
4
8
12
16
20
24
28
32
36
Annual Production Rate (mtpa)
© 2012 - Ian Runge
Producers Dilemma [Prisoners Dilemma]
What Everyone Else Does
Restraint
Expand
Restraint
What
Your
Strategy
Should
Be
Ideal World:
Supply Increased
consistent with
Growth in Demand
Expand
© 2012 - Ian Runge
Producers Dilemma [Prisoners Dilemma]
What Everyone Else Does
Restraint
Restraint
What
Your
Strategy
Should
Be
Expand
Dominant Strategy:
Everyone Expands,
Prices Fall
"profitless prosperity"
Expand
© 2012 - Ian Runge
Good Management, Good Economics, Where did we go wrong?
• We were conservative in our pricing assumptions
• We didn’t over-commit in output ... the deposit can sustain a
much bigger mine than we used as the “base case”
• We built in Real Options to change
• Our focus, as soon as the mine was up and running was to start
optimization studies [unambiguously suggesting expansion]
• We thought “strategically” .... taking into account the possible
actions and reactions of other suppliers/customers
• And yet we still ended up in a place where we didn’t want to be
(depressed prices, oversupplied market, poor returns)
© 2012 - Ian Runge
Previous Mining Booms / Current Boom ?
• Australian Mining Companies under-capitalized
• Customers and Trading Houses with Equity in Mines
• Other Powerful Players with conflicting interests (production
focus, not profit focus)
• Ill-disciplined sources of finance, inexperienced operators
• Australian mining companies pursuing strategies that advanced
their own agenda at the expense of other mining companies to
the benefit only of customers
• Corporate Perspective: things a little different this time around
© 2012 - Ian Runge
Operational Preparedness
From: An era of project development and production focus
To: An era of economics and efficiency focus.
Can we make the transition?
© 2012 - Ian Runge
The Economics of Mining:
Is the Boom already becoming a Bust,
and are we prepared?
Ian Runge
[email protected]
57