Of mines and men
A much-discussed topic in the bullion market is the persistent failure of high prices – well in excess of the marginal cost of production – to translate into higher gold output. Gold is one of the few commodities where production has fallen despite a tripling in price in just a few years.
Production constraints are evident at all levels of the supply-chain and in virtually all producing regions. Traditional economic theory implies that prices above marginal costs of production of a good, in this case gold, will attract resources to the sector, thus stimulating production and increasing supply. The increase in supply generally brings prices that are more in line with marginal costs. To date, this has not occurred in the precious metals mining sector, with the exception of silver. Gold output in particular remains stubbornly sluggish in the face of high prices and increased investment. Part of the answer may lie in the enormous barriers to entry that prevent economic agents from easily moving into the mining sector. Mining is a highly specialized enterprise and increased investment – at least in the short term – cannot be counted on to quickly raise production. In fact, greater investment has conspicuously failed to occur in the case of gold and the other precious metals.
More a question of geology than economics
A major constraint in increasing bullion production is the noticeable decline in ore grades in recent years, which makes it increasingly difficult for producers to replace reserves. The four traditional large producers, South Africa, Canada, the United States and Australia, have dominated gold production for over 100 years. Among the mining and geological community, there is wide agreement that most of the easily accessible high- grade surface and near- surface deposits have already been discovered and developed. This has compelled the industry to look further afield to less abundant regions, often with higher costs and more limited return in terms of output. Much has been made in the popular press of the depletion of accessible oil reserves. Those who hypothesize the world is soon approaching maximum oil production have coined the term “peak oil” to describe their view. In many ways however, it makes more sense to talk in terms of “peak gold” given declining reserves and low ore grades. Additionally, there are fewer mining projects, especially large- scale projects, being developed than at most periods in the last 50 years. Some of the explanation for this lies in a more rigorous, and some would say tedious and exhaustive, regulation and permitting process, which has the effect of delaying projects. Mining executives now devote significant legal and managerial manpower to the permitting and planning process.
As stated, the paucity of new mine projects, particularly in traditional producing areas, has compelled miners to search further afield to replace declining reserves. These projects are often in remote and inhospitable regions, and often present significant logistical, technical, legal, and sometimes even security challenges for producers. There is a need to establish an infrastructure capable of sustaining advanced mining projects where usually no extensive infrastructure exists. This infrastructure can include the construction of roads, railroads, housing, power, water treatment plants and medical facilities. Producers themselves have often taken an active lead in establishing the foundations necessary to support mining.
Furthermore, host nations and labour unions are well aware of the high prices of precious and other metals and can look on commodity producers as a source of additional revenues. This change in attitude has led in some cases to labour disputes and work stoppages, the renegotiation of tax and production-sharing agreements, increased royalties and the introduction of restrictive mining legislation, all of which have discouraged the development of new projects.
The increased efforts by host governments to safeguard what are seen as national assets is a global phenomenon described by political scientists as resource nationalism. A 2007 study on resource nationalism by the Council on Foreign Relations found that rather than use the largely discredited method of outright nationalization of physical assets, host nations are more likely to exert influence through regulation, production-sharing agreements, and taxation. The Council report stated that for resource-rich developing nations, such moves have domestic political significance, as they are often an important signal of sovereignty and have strong populist appeal. The popularity and trends in resource nationalism tend to reflect the price cycle. The high price environment of the 1970s, for example, saw the growth of what would now be called resource nationalism. The decline in commodity prices from the mid-1980s through the 1990s saw a reduction in the potency of resource nationalism as host countries competed for limited investment dollars. The current commodity price environment has undoubtedly gone hand-in- hand with the resurgence in resource nationalism.
The combination of constrained supply dovetailing increased demand has effectively increased the negotiating position of resource- rich host nations. It is also important to note that unlike companies in other sectors, which may shift operations from one country to another, metal producers assets are immobile and therefore abandonment of a project is an extreme decision that is taken only in extremis. Political instability can also be an issue in mining. Although by all objective measures, there is considerably more political stability in commodity producing regions than even a few years ago, instability where it occurs can be an impediment to production. An uncertain political environment could lead mining companies to focus on exploiting shallow, quickly and easily accessed deposits with a view towards moving on at the earliest opportunity. In more sophisticated, better regulated environments, mining companies will be more willing to invest in long-life mines.
That said, it is important not to exaggerate the negative impact on mine production of the resurgence in resource nationalism. Governments and labour unions, it should be remembered, have an obligation to make the best possible deals for their populace and membership. Furthermore, the impact of resource nationalism is not always straight- forward. Governments interact with producers on a host of levels with different objectives and priorities. Policies that may appear to be driven by resource nationalism may in reality be motivated by other drivers, such as protection of the environment. In short, resource nationalism can be difficult to identify and is often blamed for a multitude of unrelated issues.
The lack of new blood
Greater investment can overcome impediments to production, but even increased investment cannot in the near term raise skill or education levels. Producers face a growing problem in recruiting and retaining a skilled workforce. Mining is a highly specialized and technical process that requires a wide set of skills ranging from geologists, metallurgists, mining engineers, industrial chemists, management and legal talent and a host of skilled mine and face workers. The industry suffers a shortage of talent at all levels which is serious enough for governments to take notice.
The Canadian Ministry of Northern Development and Mines estimated the mining industry in Canada alone can expect massive labour shortages and ongoing project delays if steps are not taken to curb the skills shortfall. The Ministry estimates this shortfall could reach nearly 100,000 industry professionals in Canada within the next decade. The Ministry’s findings strike a chord with a study done in Australia, where the Minerals Council of Australia estimated that by 2015, Australia alone would need 70,000 mining employees on top of the 120,000 it has now. An article in The New York Times earlier this year said mining recruiters report industry salaries have climbed over 20% in the last two years. A previous article in The New York Times reported that a post-graduate from a good American mining school could expect a beginner’s salary on a par with a Harvard MBA. Personnel shortages extend beyond the professional and managerial staff. Skilled labour is increasingly hard to hire and keep. Special class electricians and diesel fitters, for example, are especially difficult to recruit, as are experienced shift foremen. This allows staff to pick and choose assignments, so that projects in remote areas become particularly tough to staff. Miners have families too! A skills shortage of trained engineers and other professionals necessary to the mining industry is highlighted by the findings of a skills survey by Landelahni Business Leaders as reported by the Times of South Africa. The survey reports a disturbing trend in South African higher education. The number of engineering students across all disciplines, including mining, had fallen to 11.5% of enrolments. For the period under review, 1998 to 2006, only 35,511 engineers graduated from South African institutions of higher learning, out of a total of 304,240 people who enrolled for engineering degrees. In 2006, there were 305 graduates in mining engineering, up from 61 in 2003.Metallurgical engineering graduates topped 220, up from 100 over the same period. There are just 14,234 professional engineers registered for all disciplines. This small pool of trained engineers for the industry to draw on will make it difficult for the mining sector to expand. Sandra Burmeister, the CEO of Landelahni, is of the opinion that there are simply not enough students in the “pipeline” to meet the demand of an ageing workforce. The number of candidate engineers enrolled in programs by December 2007 had fallen to 3,499 from 4,733 a decade earlier, according to statistics from the statutory Engineering Council of South Africa (ECSA).
The competition for talent is so fierce that qualified and experienced personnel find it relatively easy to travel between nations. This “brain drain” is primarily from Africa to Australia and Canada. The Business Times of South Africa cites comments from emigration consultants, who report a significant increase in emigration this year. The Engineering Council of South Africa estimated earlier this year that one qualified engineer was emigrating from South Africa almost every day. Arguably, the relocation of one mining engineer, metallurgist or geologist should not result in a measurable decline in global gold output, as a loss to one country is a gain to another. It is, however, damaging for the local industry and it should not be forgotten that, despite production difficulties, South Africa still has the most extensive gold reserves in the world. Consequently it is difficult to envisage a major increase in global mining output without a turnaround in South Africa. This may be impossible to achieve for as long as there is an exodus of mining professionals. What is more important is the overall decline in graduates in the geosciences. The trend in the United States, traditionally a leader in the geosciences, is particularly alarming.
Data supplied by the American Geological Institute show enrollment in undergraduate geosciences programs begins a pronounced uptrend in 1963, which accelerated in the 1970s and peaked in 1983/4, whereupon enrolment begins a sharp slide. There are many reasons for this sudden drop off, including the decline in commodity prices and a retrenchment in the oil & gas and mining industries which reduced job opportunities. Current enrolment however – despite a well publicized commodity boom and higher salaries – remains low and is barely at the levels seen in the early 1970s when the US population was significantly smaller. Graduate enrollment in this period also fell but not as dramatically. Part of the explanation may also lie in the attraction that quantatively minded students developed from the 1980s onward for the biosciences, high technology industry and even the financial services sector. Many students who would normally have gone into the geosciences and might have logically gone to work for an oil or mining company have instead been attracted into high tech (think of the enormous growth in computer science graduates that provided the workforce for the dotcom bubble), pharmaceuticals or what are seen as more “glamorous” scientific pursuits such as marine sciences and environment studies. In fact, traditional industries, particularly “smokestack” industries such as mining and oil, have had to combat a negative stereotype that may have actively dissuaded enrolment.
Demographics are also working against the mining industry. By some accounts the average age of a mining engineer globally is 52 years. The graduate from the bulge of the 1970s and early 1980s are ageing and a high number are due for retirement in the next 5 years. The dearth of talent has resulted in engineers and others being drawn out of retirement. In the end however, there is no easy way to make up for the lack of new graduates entering the field nor can the shortage be alleviated by a sudden increase in enrolment, were that to happen. It takes years of training after graduation to develop the skills and experience necessary to manage large projects.
Similar patterns are reflected in the age group of faculty members teaching in the geosciences, with a high number of faculty members above the age of sixty and a surprisingly high number over the age of seventy-six, according to the American Geological Institute. While the corresponding data for enrolment in other parts of the world are not as easy to gather, we believe similar trends can be established in most nations with a history of high geoscience enrolment and a historically active mining sector.
A global shortage of equipment and transportation capacity and infrastructure is also hampering output. A recent article in Engineering News discussed the high demand for earth-moving and excavation equipment, as well as the worldwide shortage of specialty tyres. According to the article, neither Bridgestone nor Michelin executives believe the demand for oversized tyres will be met anytime soon, and some mining companies have begun to use tyres manufactured in China. In a novel approach some producers have even gone so far as to enter into agreements with machinery suppliers or purchase them outright.
Producers clearly face a range of challenges in their efforts to increase gold output. While capital as a rule can always be attracted into a sector provided that profits are high enough, the gold mining sector presents producers with a unique set of obstacles, including massive entry barriers, geological and geopolitical uncertainty, a lack of readily available specialized equipment and infrastructure as well as a chronic shortage of professional and skilled personnel. In the short term, money is not necessarily the answer to overcoming these impediments to production. It may not be until graduate recruitment rates rise and a new generation of trained and experienced professionals revive depleted manpower levels that gold producers will be able to raise aggregate production. Higher starting salaries and the attention the commodity boom is receiving in the popular media may encourage greater enrolment in the geosciences and related subjects – provided the educational staff is on hand to accommodate an influx of students. What is abundantly clear to all those involved in the gold producing industry is that the coming years are going to present finance and engineering staff with a huge challenge. It will be fascinating to see how they rise to it, as they undoubtedly will.
James Steel is HSBC’s Chief Commodities Analyst with specific responsibilities for precious metals. Jim joined HSBC in May 2006. Previously Jim ran the New York research department for Refco, a large US commodities brokerage house. Jim also worked for The Economist in the Economist Intelligence Unit covering commodity producing nations.
Jim’s primary duties at HSBC include the production of daily market reports, including long term outlooks for the precious and base metals. These include supply/demand and price forecasts, as well as qualitative analyses. Jim is a frequent speaker at commodities related conferences. He is often quoted in the financial media and frequently appears on CNBC. Jim studied economics in London and New York.