Resource mining around the world has always elicited much interest from governments, employees and populations in general. The concept of extracting wealth from sovereign territory has always led to vexing questions about how the wealth and proceeds are split between those that are prepared to invest the capital, those that do the dirty (and often dangerous) work and the people and government that live in and run the country.
These questions, and the rhetoric and noise around them, always become more heated during periods of high commodity prices as the prize is worth a lot more, and generally it dies down as commodity prices fall and the relative attractiveness of the industry wanes. This is what makes the current imbroglio in the South African mining industry so peculiar, in that it is happening at a point in time when very few South African mines are profitable on a cash basis, let alone before repaying their cost of capital.
Before we get into the nuts and bolts of what is happening currently in the South African mining sector it is worth reviewing the industry generally and how investors have historically made their returns and what risks are faced in doing this. Mining has always been, and remains, a risky business. This is why we generally view mining as a "discount" business, one where over time we as investors would expect and demand a higher return, on average, to account for the risks we take in the sector.
Mining is a capital intensive business. It requires large amounts of capital be spent upfront, before any revenue has been generated. Bigger mines tend to be more profitable over time due to the benefits of scale, but they do run the risk of overspend or miscalculations as to the richness of the orebody being mined. Once the capital has been committed, and the earth moved, and buildings and shafts built, this infrastructure is fixed and cannot be moved. The investor is therefore often taking a view on returns over a long period, at least 20 years or longer, during which time a lot of things can and do go wrong. The construction itself often takes years to be completed during which time debt incurs interest costs while no earnings are being generated. All of this ultimately needs to be repaid.
The implied political risk is also significant as governments can and do change many times during the life of a mine, exposing the operation to changing regulatory risks.
Geological mapping and resource testing have become a lot more sophisticated from the days when a statement of "There’s gold in them thar hills" was enough to spur a gold rush and a mining town boom. However, it is still not an exact science and determining the richness and ease of extracting orebodies remains a huge risk.
Article continues on pages two, three, four and five: why mining in South Africa is so expensive; the current situation in South Africa; the future of mining in South Africa...