Mario Arregoytia
Lead Partner for Mining and Metals for Mexico and Central America
Ernst & Young
 Amber Nelson
Amber Nelson
Markets Enablement Manager
Ernst & Young
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View from the Top

Global Solutions Pooled for Local Mining Markets

Wed, 10/21/2015 - 15:12

Q: How does the Mining and Metals Division of Ernst & Young (EY) keep its finger on the pulse of the mining industry in order to provide the best services?

MA: EY keeps a global and local vision for all industries, especially for mining which is, by nature, a global industry with particular local circumstances and necessities. We help our clients in the local mining industry to know about the options that are available and favorable for them at a global level. We always consider the risks and associated challenges that they face and help them identify the opportunities beyond such problems so that they may come out winning. Our industry experts are located worldwide and are available in a flexible and efficient way. This approach means that we do not need people in each and every mining region. For one recent meeting with a big client, we brought in a logistics expert from South Africa, a tax expert from the US, and a copper expert from Peru. Alongside this worldwide presence, we also have a Global Mining & Metals Center in Sydney which acts as a hub for the mining industry.

Q: How can mining companies operating at all stages of the value chain balance the demands of short-term shareholders with those investing in longer-term returns?

MA: An industry that produces significant yields attracts many investors with short-term expectations. However, when this industry starts to decelerate, those investors are left with two options: they can either evaluate the long-term nature of the industry while keeping the shares of reliable companies, or they can sell their shares and invest their money in another industry. EY offers the option of exploring alternative financing options to lessen the dependence on bank loans and direct investment, reducing the gap between investor expectations and the reality of the industry. We help companies looking for alternative financing options to understand the associated costs of options such as royalties, metal streaming, and equipment/EPCM leasing agreements. Of these options, we have noticed that streaming is currently very popular. Copper producers in Mexico, Chile, and Peru are streaming their silver by-products to silver streamers. For this option, it is very important that the company negotiates the agreement very well because if the terms are not negotiated appropriately, the company may receive cash at first but suffer a significant loss in the long term. Another viable option is to intensively make use of equipment leasing agreements, although companies need to be very careful of equipment cost trends when entering into them. The secret is to identify a specific window when an agreement can be reached at a low price before the equipment costs go up again. For EY, it is very easy to identify benchmarks for these costs and find options in Mexico and other countries.

Q: To what extent are your clients susceptible to the risks associated with capital allocation and access to capital, and how can they overcome them?

MA: For major players, the main risk is capital allocation while junior companies are suffering more in terms of access to capital. Majors need to be able to allocate significant investments and achieve significant short-term yields for their investors. If these companies allocate capital to a project that does not have a good rate of return, investors will not support the decision. The difficulty is finding a project that will offer an adequate short-term yield during a period of decline in metal prices. In 2015, we expect that a good margin will be more important than capital allocation for big projects due to rising operating costs.

AN: The market environment was punishing in 2013, leading to the change of all the big CEOs who had made large investments. There is now a lot of pressure on companies to start returning cash instead of spending it. The risks associated with capital allocation and access to capital are closely tied to cutting costs. For example, BHP Billiton and Rio Tinto projects need to compete internally for capital and prove that they are the most economically viable options to maximize returns for shareholders. One of the ways in which companies are overcoming the capital allocation dilemma is through creativity. A company such as Grupo Mexico may need to invest in specific mining projects, leading them to cut back on non-essential projects in other industries, therefore offering investors a good short-term yield for their mining investments. They can do this until the mining industry returns to a growth cycle.

Q: What effects will the mining royalty have on the mining industry in Mexico over the next few years?

MA: In the short term, I do not believe it will have a negative effect on mining investments in Mexico because most of the major mining countries in the world have similar royalties or taxes. The problem is that Mexico used to be a tax haven for mining investors since companies only needed to pay income taxes and the Statutory Employee Profit Sharing Assets (PTU). After the implementation of the royalty, Mexico became an average country in terms of taxes. Investment in exploration projects with tight margins might also decrease in the short-term, but in most cases, good projects with good margins will not be stopped because of the royalty; they will only need to become stricter in terms of spending. In the mediumterm, up until 2017, medium-sized and large companies will optimize their costs through solid tax strategies. The Mexican government recently made a tax stabilization pact, meaning that it will not implement additional tax reforms for the next three years. But the government will probably realize that this tax scheme will not collect the funds that are expected due to the taxation strategies employed by mining companies.

Q: How competitive is Mexico in attracting new mining industry investments?

MA: Companies looking to invest will typically compare regions rather than countries. For example, a company might need to decide whether to invest in a project in Africa or in Latin America, considering that the business environment and market situation is very different in these two regions. There is no significant difference among Latin American countries in terms of mining royalties but there are other factors that can play a significant role in determining investment allocations. One of these factors is the ease of obtaining a social license. It is now more difficult to obtain a social license in Peru than it is in Mexico, for example. Additionally, Mexico has the geographical advantage of being closer to the US and it has more infrastructure than Peru. Mexico is seeing a growing trend of problems with social licenses. When a group or a community is successful at making a mining company pay additional charges for the social license, other groups or communities then decide to ask for the same benefits. Yet, this problem is a lot more significant in Peru where some external environmental organizations have begun to fight mining companies in areas such as the Amazon.

Q: How does EY help its clients to overcome such problems with communities?

MA: We offer a complete set of strategies. These strategies are not industry secrets, simply benchmarks. The solution to a community problem is achieved through a set of measures designed to improve the relationship with the community and recover the social license. If a community does not want a company to use its water, that company must work to provide water distribution solutions. The addition of water and air pollution treatments, schools, and hospitals, can also solve a variety of needs that the community may have. Problems happen when companies refuse to invest in preventing them. EY can help shelter companies from these storms before they appear.

AN: A big part of improving relations with communities relies on communication. The company needs to communicate the benefits of mining from the start. Many times communities do not understand the full benefits of having a mine in their area. We have benchmarked strategies for dealing with communities since we have a lot of experience in countries like Australia and Canada where these problems first happened. As these problems arise in emerging markets, EY can apply the successful best practices used in other countries to solve these problems.

Q: How is EY helping its clients reduce energy costs at their mining operations?

MA: The Energy Reform provides good opportunities for mining companies to establish their own electricity plant, become self-sufficient, and sell the excess energy to CFE. Two of the most significant players in the mining industry are already building their own electricity plants and will cut 50% of their total energy costs. Another option we provide is to help companies establish contracts in the shale gas supply industry in the north of Mexico or south of the US. Congress is now discussing whether or not mining concession owners will receive gas concessions for exploration. This is a new business opportunity for EY and we are bringing in oil and gas experts from Houston to work with our mining clients.

Q: With regards to the mining industry in Mexico, what are the aims of EY’s Mining and Metals Division for the next three to five years?

MA: We are quite strong at the global level but we need to be able to bring our resources together more efficiently at a local level in order to become the best regional support for the mining industry. We will look to bring in geologists to aid us in understanding geological parameters of reserves and resources, from their distribution to their abundance. We are also looking to increase our expertise in terms of sustainability, both in general and in the mining industry, in order to help the industry overcome challenges regarding the environment. It is necessary to possess these kinds of skills in order to obtain broader understanding and provide better support for our clients.