Global overview of disputes trends in the mining and metals sector (Part 1)

Volatility as the new normal

Global Publication November 2020

Introduction

There are few who would disagree that the current and near-future global risk landscape is particularly challenging to assess and navigate. It is volatile and multi-faceted, with many of the risks intersectional and in continual flux. In times such as these, considerations of agility, resilience and risk mitigation – in particular disputes-risk mitigation – must feature high on every corporate agenda. 

 

Volatility as the new normal

When looking back on 2020, without a doubt it will be seen as the point at which ‘volatility became the new normal’ globally. Significant events such as the COVID-19 pandemic, the hardening of nationalistic rhetoric, geopolitical instability, trade wars and a downturn in major economies have impacted almost every major financial market and sector. The unstoppable march of automation and digitalization has continued at pace – indeed, it has been propelled forward in 2020, leading to a fundamental reshaping of the workforce and many industries including the mining sector. Although 2020 shortly will be drawing to a close, there are few indicators yet of a reprieve. The impact of recent events will be felt for many years, with many leading commentators still warning of a downturn in all major economies and a rise in corporate insolvencies. Meanwhile, other significant geopolitical and macroeconomic risks are forecast for the near future. Some, such as climate change, are predicted to bring disruption on an equal if not greater global scale as the pandemic – indeed, disruption arising out of climate-related physical risks and transition risks (in particular, the energy transition) is already evident, and the impacts on global financial markets and industry are expected to increase exponentially in coming years. 

 

Challenges and opportunities for the mining sector 

Mining has certain intrinsic elements which further compound the complexity and variability of the risk landscape for the sector. Mining is one of a few essential sectors with a significant footprint across the globe – including by way of customer base, supply chain, group company reach, as well as physical operations. Mining investments are always capital-intensive, long-term, heavily regulated, invariably involve state or state-owned entities, and not infrequently based in emerging or challenging foreign markets and in remote and physically challenging locations. They also involve enormously valuable physical assets, which are often of strategic national value to the host state and economically and politically important to local communities. There are significant political and country-specific risks, and accordingly economic risks. 
 
As such it is difficult to offer an accurate ‘one size fits all’ global assessment of risks for mining companies or investors. However, a review of mining sector risk reports produced this year by leading analysts (including EY, PwC, KPMG, Deloitte, and McKinsey) and our own experience indicates a number of common general sector trends as discussed below. 
 
Mining is by its very nature extremely vulnerable to political and regulatory risk, and often that risk is not solely in respect of captive local operations and assets but permeates the value chain. Geopolitical and macroeconomic risks currently faced by the sector include political instability and changes to the global power balance that threaten the operating dynamics for miners (in particular the changing role of the US, EU stability, China-Australia and US-China relations), rising nationalism, trade wars, and a likely downturn in many major economies. Such risks have led to physical security risks to workers and operations, license or permitting issues, adverse regulatory change, taxation issues, direct or indirect expropriation in some instances, community engagement and license to operate issues, as well as volatility in commodities markets, to name but a few. Indeed, EY’s September 2020 mining and metals report indicated a clear protectionist trend with 58 percent of respondents expecting governments to increase royalties and taxes after COVID-19. 
 
From a financial perspective, for miners, commodity price risks remain at the top of key concerns, along with currency and credit risk. There are also related risks arising out of insurance market conditions (from a buyer’s perspective) which can impact financing. 
 
The pandemic has of course also been of concern. According to a McKinsey August 2020 survey of mining executives, COVID-19 has had a significant impact on mining operations, with 75 percent reporting moderate disruption and 65 percent expecting fundamental changes to their operational models. It also reported that on average the pandemic triggered a 42 percent decrease in production, attributable to reduction in demand and impacts on workforce availability. 
Notwithstanding this, the mining sector has not been hit as hard as other sectors. According to PwC’s June 2020 mining report, this is owing to the mining sector having come out of 2019 in a relatively stable financial position, combined with the fact that many miners have been able to continue operations during the pandemic albeit with precautions in place. In part this is thanks to robust existing safety protocols that facilitated the swift adaptations needed to minimize outbreaks of COVID-19, combined with a willingness to embrace remote working and autonomous systems. The impact of the pandemic on commodities prices has been more varied, with some up, some stable and others down. Gold and silver retained their status as safe havens. China’s swift economic rebound has kept up demand for iron ore but this is potentially more volatile. Demand for copper and battery minerals is being driven by the demand for telecoms and renewables (perhaps the oversupply of lithium is correcting). But there is concern that future disruption could see this change fast. Overall, however, PwC predicts a “relatively moderate” outlook for the sector. 
 
There have, however, been lessons for the mining sector out of the pandemic. Like most sectors, mines need to take a hard look at their critical supply chains, customer base and transient workforce in order to achieve on the one hand more global diversification and on the other hand greater localization. This will inevitably lead to new contractual counterparties and markets, as well as assessment of existing contracts. Miners are also reassessing the viability of just-in-time and lean production methods to minimize the impact of future supply chain disruption on operations. Businesses and sector reliant on mining commodities are likewise making similar assessments and adaptations to their supply chains. 
 
More generally, the traditional mining model is seen as increasingly difficult to maintain. There has been a push towards new business models, including strategic partnerships, private equity and public private partnerships. This shift is likely to continue to play out in coming years. Appetite for major deals remains low currently (understandable given the post-pandemic environment) but there remains an expectation of some new mergers and acquisition (M&A) activity, including potential consolidations and mergers of small-mid market players which might not have weathered recent volatility as well as the largest players, plus diversifications and divestments. There is also likely be an increase in joint ventures, partnerships or strategic alliances both within the industry and with new players to the sector.  
 
There remain concerns around capital, including liquidity. Growth will require investment, yet access to traditional sources of debt and equity capital is deteriorating. This is leading to alternative financing arrangements, such as streaming contracts, becoming more mainstream. In parallel, there is a focus on controlling capital expenditure and operational costs. This crunch comes, however, at a time when there are competing pressures to invest in infrastructure essential to continue operations, ensure resilience, and deliver productivity and efficiency gains. 
 
Mining companies have embraced the role of technology. Further investment in innovation and disruptive technology is seen as a key strategy for achieving growth (importantly, long term sustainable growth), reducing costs, driving productivity and efficiencies, and enhancing resilience, safety and environmental management. But there are associated risks with innovative processes and technologies. Cyber-security risk is the obvious risk given that greater automation and use of digital technology makes mining companies more vulnerable to cyberattack – and in the mining context that could literally mean matters of life or death. There are also inherent risks associated with implementing novel processes or technologies, many of which are evolving faster than corresponding laws or regulation, which can lead to unpredictability as to allocation of legal liability. Such projects often also involve partnerships or joint ventures with non-mining counterparties and in non-mining sectors, which also means inherently greater risk than traditional transactions and projects which travel well-trodden roads for miners. Last but not least, there are also equally pressing practical concerns such as how to ensure a technologically skilled workforce, as well as how to manage related community stakeholder issues arising out of the changing ways of working and the impact on the traditional workforce. 
 
Climate change is another key risk for the mining sector and an area where investment is needed. Mines are particularly exposed to the physical risks of climate change (including changing climactic conditions and more frequent and extreme weather events) given mine operations often are: based in remote, difficult to access locations (many with already challenging climactic conditions); reliant on resources, such as water, which are predicted to become more scare or harder to access; vulnerable to extreme weather events (including floods, droughts or extreme heat) which can damage infrastructure, impede operations, transport and supply chains, as well as increase the risk of environmental pollution or health and safety events; and vulnerable to the resulting security risks associated with political and economic instability that environmental pressures create for local communities and governments. 
 
Mines are also exposed to transition risk of climate change. As significant contributors of greenhouse gasses they are under increasing social, political and regulatory pressure to disclose emissions (potentially along the entire value chain), divest from carbon-intensive assets, and transition to lower-emission and more sustainable operations. Proposed new investments face significant social, political and regulatory scrutiny by governments, investors and local communities on climate change grounds. 

Managing or mitigating these physical and transition risks will require comprehensive risk analysis combined with investment in new or improvements to existing infrastructure and processes. Digital and technological innovation, including AI, IOT and data analytics, are again expected to have a significant role to play. 
 
Mines and investors are also exposed to legal and regulatory risk related to climate change. This category of climate-related risk is on the rise globally as governments implement new legislation or regulatory change to respond to the climate crisis, limit or prohibit certain activities or industries, or seek to apportion liability for the very significant costs of mitigation or adaptation. In many instances, such issues are also being fought out before national courts or international tribunals – reflecting this, in the last decade there has been an enormous surge in such cases globally. Activism more broadly, including shareholder activism, related to climate change or other ESG issues is widespread and targets of activism and litigation have expanded from governments and oil and gas companies, to other significant emitters as well as those that facilitate carbon-intensive industries (such as banks, investment and trading houses, insurers and pension funds). With those sectors facing their own significant pressure to divest and transition to lower-risk and lower-emission investments, it has had an impact on access to finance and insurance. 
 
Regulatory and legal risk is an area that requires regular monitoring and attention, particularly for global companies, given there is no common regime globally, and in each region this area of law is developing and in flux. 
 
Paradoxically, climate change also presents significant opportunities for the mining sector. The energy transition will be mineral intensive. Billions of tons of metals and minerals will be needed to develop and produce clean or green technologies. According to a World Bank Report on Minerals for Climate Action: The Mineral Intensity of the Clean Energy Transition, demand for minerals such as lithium, cobalt, copper, aluminum, graphite and nickel is expected to grow up to 500% 
by 2050. 
 
Related to climate change risk is a continued focus on broader environmental, social and governance (ESG) issues, including modern slavery, along the entire supply chain. Increasingly, there is a close link between ESG and raising capital, with ESG requirements becoming more stringent, and pressure pressure on disclosure and reporting. Likewise, social license to operate and indigenous rights remain a hot topic. Ignoring these issues (whether through systemic failures of governance or just failure to take sufficient account) can have disastrous consequences, with both C-suite and reputation taking a major hit, as well as potential legal or regulatory proceedings.
 
Developments such as the energy transition and digitalization are also bringing new players into the mining sector. Non-mining companies have started to participate more directly in the industry – whether as participants in novel joint ventures or other arrangements (such as is seen in renewable power arrangements) or as investors seeking to increase control or even take ownership over production of minerals needed for their primary business. Businesses reliant on mining for materials are also looking to directly or indirectly influence the mining sector and even transfer risk as they themselves face pressure, for example to demonstrate sustainable supply chains.
 
As just one example of the rising involvement of non-mining companies, in September 2020, Tesla officially entered the mining sector, announcing its lithium claim on 10,000 acres in Nevada and the development of its own lithium extraction and processing method. Reportedly, this lithium would be enough to support electrification of its entire US fleet. It would also achieve another goal of localizing its cathode supply chain and production as well as reducing the miles travelled by materials used in production. Weeks prior, Elon Musk promised a “giant contract for a long period of time if you mine nickel efficiently and in an environmentally sensitive way.” 
 
Such participation – and indeed competition – from companies that traditionally have not operated in the mining sector will inevitably lead to change to business practices and may even ultimately shape the future of the industry.
 
In the following companion piece to this article, Global overview of disputes-risk avoidance and mitigation for the mining sector (Part 2), we explore the disputes trends for the sector and ways of mitigating disputes-risk. 

 

Global overview of disputes-risk avoidance and mitigation for the mining sector (Part 2)

 

 

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