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Sustainable development: can the mining industry afford it?
Resources Policy 27 (2001) 1–7 www.elsevier.com/locate/resourpol
Viewpoint
Sustainable development: can the mining industry afford it?夽 D. Humphreys
*
Rio Tinto Plc, 6 St. James’s Square, London SW1Y 4LD, UK Received 30 January 2001; received in revised form 8 February 2001; accepted 10 February 2001
Abstract Adopting the values of sustainable development implies an increase in the mining industry’s environmental and social costs. For an industry already offering poor returns on capital this is potentially a problem. An examination of the historical record, however, reveals that past increases in environmental and social costs have been more than offset by developments in industry productivity. The emergence of information and communication technologies seems likely to extend this trend into the future. The particular challenges being faced by mining in the US appear to be less to do with rising environmental costs than with competition from countries which have recently opened up to foreign mining investment and to a strong dollar. It seems likely that industry’s adoption of more sustainable practices will require, and could even promote, improved returns to capital in mining. 2001 Elsevier Science Ltd. All rights reserved. Keywords: Mining profitability; Sustainable development; Environmental costs; Productivity; Information and communications technologies; USA
The proposition to be explored in this paper is that the profitability of the mining industry — already poor — is about to get worse as a result of rising cost pressures associated with the social and environmental demands of sustainable development. A secondary objective is to ask whether US miners are set to suffer disproportionately in this process. Profitability and cost pressures It is certainly the case that the financial history of the mining industry is an undistinguished one. As Fig. 1 illustrates, data going back over the past 27 years reveal that the resources sector as a whole has achieved a reasonably respectable 8% average real rate of return on capital. However, this achievement is entirely down to the oil and gas sector which in 1999 had a market capitalisation some eight times that of mining. Real returns for mining have been a much more modest 5%, pos-
夽 This paper is based on a presentation at the Northwest Mining Association’s 106th Annual Meeting, “Winds of Change”, 4–8 December 2000, Spokane, WA, USA. * Tel.: +44-171-930-2399; fax: +44-171-930-3249. E-mail address: [email protected] (D. Humph reys).
Fig. 1.
Profitability by industry sector.
itioning it alongside so-called “basic industries” such as steel, construction, forestry and chemicals. This is the background against which the mining industry now confronts the possibility that cost pressures on it are about to intensify as a result of increased social and environmental demands associated with a move to sustainable development. There is an argument, which generally goes under the heading of “eco-efficiency”, that environmental improvements go hand in hand with improved industry efficiency. In other words, there are “win–win” opport-
0301-4207/01/$ - see front matter 2001 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 1 - 4 2 0 7 ( 0 1 ) 0 0 0 0 3 - 4
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D. Humphreys / Resources Policy 27 (2001) 1–7
unities which avoid the necessity of making difficult trade-offs between what makes good business sense and what is good for the environment. Higher mineral recoveries obviously mean less waste and lower waste disposal costs, while higher energy efficiencies mean less carbon emissions and lower operating costs. There is undoubtedly much in this argument. However, it is far from the case that all expenditures on social and environmental matters bring about cost-savings. Many such expenditures are a straightforward internalisation of that were previously external costs; which it to say, costs picked up by society at large in the form of the degradation of air or water, or the despoliation of landscapes. The reinforcement of a tailings dam or the sterlisation of part of an ore body for environmental reasons may allow a miner to continue in business but they generate no rates of return. The same applies to the reclamation and rehabilitation of worked-out mine sites. Community programmes are real costs, without necessarily any immediate offsetting efficiencies. So also are the permitting costs which miners must incur before they have cash-flow, always assuming, that is, the permitting process enables them to get one. Quite what the scale of these internalised costs is it is hard to determine. This is partly because some costsavings, of the eco-efficient variety, would have been done anyway, while others are not specifically identified as social and environmental costs but treated as a normal part of doing everyday business. Company accounts do not typically contain headings distinguishing environmental costs, and those identified as social costs will tend only to relate to specific programmes. Were it possible to break out the role of social and environmental costs, they would probably not be that high anyway for the simple reason that many of these activities are today built into the way projects are set up to run. (This will not necessarily be the case at older operations where companies are having to play catchup.) For the most part, it is more likely that additions to costs arising from higher environmental and social standards will be found in the capital component of mine projects. In one of the few attempts to put numbers on these things, Metals Economics Group (1993), in a survey of gold companies in 1993, found that respondents considered environmental provisions accounted, on average, for only 3% of their operating costs. However, they claimed they accounted for around 12% of their feasibility costs and 14% of their development costs, with the figures rising to 22% and 17%, respectively, in more demanding jurisdictions. Data produced by Statistics Canada (1997) show environmental protection accounting for some 23% of capital expenditures in the mining sector and, on a totally different definitional basis (one which includes “any expenditure that ensures or anticipates compliance to environmental regulation or official
voluntary agreement”), for 77% of operating expenditures. But whether incurred in operating or in investment, these are still real costs which make tougher the challenge of an industry seeking to improve its returns on capital.
Productivity and industry returns Against this backdrop, it might seem likely that the arrival of sustainable development as a social objective generally, and as an objective for the mining industry in particular, must, by adding to costs, compromise its profitability further. There are, however, certain problems with this notion. Not the least of these is that the industry has been improving its standards of social and environment performance over very many years already, during which time mining costs have fallen substantially. How is this so? Here we encounter one of the great unsung achievements of the mining industry, its extraordinary and sustained growth in productivity. The record of productivity growth has enabled the industry to offset rising costs associated with the adoption of higher social and environmental standards, combat the tyranny of declining ore grades and, over some periods, still achieve a reduction in real costs of production. Indeed, this decline in real terms production costs is the basis for the long run decline in real prices of many commodities. A particularly fertile source of information on US mining productivity is the US Bureau of the Census. This permits analysis of the mining industry back to 1860. Looking first at its data on copper, it can be seen in Fig. 2 that over the past 140 years, labour productivity per tonne of copper contained in ore has increased at an average rate of 3.4% a year, a total improvement for the period as a whole of over 100 times. Moreover, as indicated by the logarithmic trend, the rate of improvement has been remarkably consistent over the period covered. Considering the productivity of ore milled rather than copper contained in the ore — in many respects a fairer
Fig. 2.
Productivity growth in US copper mining.
D. Humphreys / Resources Policy 27 (2001) 1–7
measure of productivity since it recognises that ore grades have fallen over time — then the productivity growth is around a percentage point higher again. As regards costs, although the trend overall has been down, bearing out the proposition that it is possible to absorb increased social and environmental costs, combat declining grades, and still achieve a reduction in production costs, the experience has varied significantly over different periods. Recession during the 1930s forced a reduction of industry production costs, partly by forcing closures of higher cost capacity, but unit costs subsequently pushed upwards as ore grades declined. Since the early 1980s, real unit costs have fallen sharply, again partly as a result of closures at high cost mines and improvements at the remaining mines producing copper concentrates, but also because of the emergence of a new recovery technology in the form of solvent extractionelectrowinning (SXEW). Similar developments have been experienced in iron ore. Here, as Fig. 3 illustrates, labour productivity has increased at an average rate of 2.5% over the last 140 years; a more modest, though still impressive, 27 times. As in the case of copper, the improvement in productivity has been relatively consistent throughout the period. Also, as with copper, the impacts of these productivity improvements have been slightly less straightforward. The effects of growing economies of scale and then of the Great Depression are evident in the decline of costs through to the 1930s. Thereafter, costs started to rise as the industry was forced to move from direct charge haematite to the upgrading of taconite ores into pellets. Leaving aside the distortions associated with the strike-affected year of 1977 and the recessionary year of 1982, there is the suggestion over the past forty years of a modest decline in the real unit production costs of marketable iron ore in the US. Against the evidence of 140 years, it would be a brave person to claim that opportunities for further productivity improvement in the mining industry have been exhausted. And in fact, at the same time that the mining
Fig. 3.
Productivity growth in US iron ore mining.
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industry has been shaping up to the demands of sustainable development, so a whole array of new possibilities for improving productivity has arrived in the form of e-technologies, or information and communications technologies (ICTs) as they are more properly known. The contributions of ICT to productivity in mining come about in a rather different way from those associated with much of the earlier productivity growth. Conceptually, production growth flows from one of three sources, capital inputs, labour inputs and total factor productivity. This last element is a measure of the efficiency with which capital and labour inputs, along with intermediate inputs such as purchased services and energy, are used, and incorporates a wide variety of influences such as improvements in embodied technologies, management systems and labour practices as well as the effects of regulatory changes, economies of scale and resource quality. By their nature, these influences are difficult, if not impossible, to measure separately and directly. They manifest themselves statistically as a “residual” after the effects of capital and labour, which are measurable, have been taken into account. For much of the period covered by US Bureau of the Census data, many of the productivity gains achieved are fairly readily traceable to capital injections in the form of better equipment, larger trucks and shovels, improved rail and port infrastructure, and so on. Productivity growth from these capital injections will have been both encouraged and facilitated by two other factors. The first of these is economies of scale, which have permitted the use of larger and more productive equipment. Fig. 4 shows how the proportion of copper produced by mines having a mill capacity of over 10 million tonnes of ore a year has risen from 20% in 1970 to over 70% today. The second factor is energy prices, the decline of which in real terms over extended periods has encouraged capital-labour substitution. Although capital injections will doubtless continue to play a part in industry’s growing productivity, an important — and perhaps increasing — role appears to
Fig. 4.
Share of copper produced by size of mine.
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D. Humphreys / Resources Policy 27 (2001) 1–7
be being played by the influences incorporated into total factor productivity, including ICT. A recent study on productivity growth in the US, although intended to illustrate the problems of output measurement in some of the sectors using ICT most intensively, incidentally drew attention to the remarkable growth in TFP in the mining sector. As Fig. 5 shows, between 1987 and 1997, TFP in mining is estimated to have grown at 4% a year. It is possible, of course, that some special factors applied to the industry over this period. However, they are similar to the results of a study by Ian Parry for Resources for the Future, published in 1999 (Parry, 1999). This showed TFP growth for 1982–1992 of 3.9% for copper mining, 2.6% for coal, 1.3% for petroleum, as against 1.4% for manufacturing as a whole. It is plausible that improvements in ICT in recent times, including most recently the influence of the internet, are underpinning this tendency. The use of ICT in mining is, of course, scarcely new. What is new, however, is that the range of what it can be applied to is being significantly extended. In addition to more traditional areas of ICT application in exploration and operations, ICT is increasingly being used in areas having a less direct, but still important, impact on costs such as integrated business process systems (sometimes know as Enterprise Resource Planning systems), e-procurement systems, as well as shared back-office services and coordinated marketing and shipping. With the assistance of these developments, and of others such as the adoption of low capital processing technologies like heap leaching and bio-oxidation, it seems more than likely that the productivity of the mining industry will continue to grow into the future. These productivity gains will in turn assist the industry to respond to the growing demands imposed on it by sustainable development, as in the past they have enabled it to respond to rising social and environmental costs. A shift in the emphasis of productivity growth in the industry away from capital towards technology and improved work practices also raises interesting questions about the industry’s future capital demands. The valueadding qualities of ICT derive primarily from changes
Fig. 5.
US total factor productivity by sector.
they bring about in the way organisations work rather than from the purchase of big ticket items. Such a switch in emphasis represents a practical response to the charge that the industry has tended to overcapitalise in the past and that this has contributed significantly to the difficulty it has had in delivering satisfactory returns to its shareholders. Or to put it in more familiar terms, the growth in emphasis on ICT and on its role in promoting total factor productivity is consistent with a shift in industry emphasis away from capital spend towards capital efficiency.
A perspective on the US In addition to the general cost implications of growing social and environmental obligations for mining, a second focus for concern is that these costs can vary substantially between different parts of the world and that they may be having a disproportionate impact on miners in some of the more mature economies such as the US. A brief inspection of where exploration expenditures in the industry have been going over the last decade would seem, on the face of it, to support this suggestion (Fig. 6). While exploration expenditure soared through the decade of the 1990s before being hit by the fallout from the Asian Crisis, spend in the US showed only the most modest gains up to 1996 and 1997, all of which (and more) it has subsequently given up. It is self-evidently the case that the cumulative effect of environmental regulations makes life tough for miners in the US. But this is the fate of many basic industries located in rich countries which feel they have the choice over whether or not they continue to need to host such activities. The situation is little different in Europe where miners are generally subject to environmental conditions as tough as those in the US and where competition for space from alternative land uses is probably even more acute. There is, however, another dimension to this issue,
Fig. 6.
Industry exploration expenditure by region.
D. Humphreys / Resources Policy 27 (2001) 1–7
which is that the US has a clear and workable system of laws which, while they may be tough, nevertheless provides reasonable conditions of certainty for the businesses subject to them. In addition, the US offers political stability, an educated workforce, a functional and predictable tax system, good infrastructure and sophisticated health and welfare support. By contrast, in some of the developing countries in which mining companies operate, considerations of sustainable development bring within them obligations to consider a much wider range of social commitments than is the case in the US. These may cover education and health, programmes for promoting local economic activities, support for indigenous peoples, and even basic institution building. These all come at a cost to the companies, a cost which in the US can be shared with a wide range of other contributors. In many developing countries they have to shoulder them on their own. Moreover, while environmental laws may or may not be formally as stringent as in the US, companies cannot risk adopting standards which are lower and which may become unacceptable in a few years time. There are inevitably uncertainties about such judgements. However, in surveys of what drives investment decisions on investment behaviour in the mining industry, the stringency of environmental regulation generally comes some way down the list of considerations of concern, and a long way after such matters as security of legal tenure, political stability, and the ability to repatriate profits. For the reasons behind the poor performance of the US in the world exploration league over the past decade it is necessary to look elsewhere. The first point of note is that political changes elsewhere in the world have led to a widespread opening up of opportunities in countries previously off limits to overseas mining investors. Throughout Latin America, Asia and Africa, the end of the Cold War and the rolling back of the state have led country after country to seek to position themselves to benefit from an inward flow of private mining capital. Over 100 countries have re-written their mining laws since 1985. The US, Australia and Canada benefited relatively in exploration through much of the 1980s from the fact that most other countries looked too difficult. More specifically, they also benefited from the development of new gold provinces, a high gold price and some favourable tax provisions. In the 1990s that changed, and while the US may have lost out relatively, generally mining and exploration activity thrived. The switch of investment away from the US, and also to a lesser degree Canada and Australia, was motivated by the conviction that here was a once-for-all opportunity for mining companies that they could not afford to pass up. It cannot be viewed simply as an expression of disenchantment with investment conditions in these three countries.
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Fig. 7. Copper breakeven production costs.
The second factor drawing mining investment away from the US is a simple piece of economics. The success of the new economy in the US and the high flow of funds into the US chasing new economy investments led to a strong US dollar. Already a high wage economy, this has made the US a tough place for basic commodity businesses in which branding and patenting offer little, if any, scope for producers to protect their margins in a highly competitive international market. The point can be made by looking at the trend in cash costs for copper production over two or three decades. As can be seen from Fig. 7, the US copper industry has dramatically reduced its production costs since the early 1980s. Average cash breakeven costs have effectively been halved in real dollar terms over this period. This has been accomplished partly by the closure by high cost capacity, and partly by cost reductions at existing operations and by the growth of SXEW production. While it may well have been the case that the prospect of having to make significant expenditures to remain environmentally compliant was a contributory factor in some of these mine closures, it is unlikely to have been the determining factor where mines otherwise had the potential to remain competitive. These changes have enabled US miners to close the gap on producers elsewhere in cost terms. Despite this, the US remains a relatively high cost producer in world terms. Fig. 8 chart sheds some light on why US miners have
Fig. 8.
Copper costs and the US dollar.
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D. Humphreys / Resources Policy 27 (2001) 1–7
struggled to maintain international competitiveness in spite of these achievements. In this figure, US copper mine costs are shown as a ratio of average copper mine costs outside the US. (In contrast to the chart above, costs are here presented on a pro rata basis to suppress the complicating impacts of by-product credits on underlying copper costs.) It also shows the US dollar’s effective exchange rate over the same period. The effect of high dollar values on the international competitiveness of the US copper industry during the mid-1980s is apparent. So also is the diminishing competitiveness of the industry through the second half of the 1990s as the dollar went through another period of strength. The US may have the highest productivity levels in the world but it is a big ask for the industry to outperform the rest of world’s industry to the extent necessary to compensate fully for these currency effects.
Sustainable development and industry returns: a coincidence of interests To return now to the question posed by the title of the paper, “sustainable development: can the industry afford it?” In a sense, this is a non question. The industry is going to have to address the demands of sustainable development and it is going to have to afford it. Society has been clearly signalling to the industry that the traditional ways of doing things will simply not be acceptable in the future. The only meaningful question to be addressed is how the industry intends to respond. Some aspects of the way in which the industry seeks to internalise the values of sustainable development will have a material cost impact and the industry will have to be looking to ways to offset these costs through productivity growth, as it has done in the past. Consistency with their economic objectives suggests that, in seeking to boost their productivity, companies will increasingly favour low capital solutions. Other aspects may have less to do with spending money than with a more enlightened management of industry’s relationships with the public, with NGOs, with local governments and customers. More than ever, the industry cannot afford the tensions and disruptions associated with unhappy neighbours, not to mention any resulting litigation. Nor can it afford to bank on the unquestioning support of a financial community which is becoming more nervous about funding natural resource developments because of negative public perceptions. Access to resources and to the finance to bring them to production are the life-blood of the mining industry and to achieve and sustain such access the industry needs public understanding and support, not just legal approvals. Formal permitting is, and will remain critically important to the industry, but it will not buy a company a social right to operate. In short, the industry can-
not afford not to sign up to the values of sustainable development and to live out these values in practice. There is simply too much at stake. Having to absorb the costs associated with the transition to sustainable development is one thing, doing so in a positive and profitable way is quite another. Which brings us back to the issue raised at the beginning of this presentation; the poor long run profitability of the mining industry. The roots to this problem are largely independent of considerations of social and environmental costs. Although the subject of another paper, a strong case exists for believing that the problem of poor returns is a product of industry’s own economic behaviour, specifically its tendency to over optimism on demand, over investment in new capacity and over capitalisation of that capacity. That said, the achievement of improved rates of return on capital is not unrelated to industry’s ability to deal constructively with the challenges of sustainable development. Indeed the two are intimately related. A more profitable industry will clearly be better able to respond to the growing demands of sustainable development. More than that, an industry which is more focused on the sustainability of its own activities will be better attuned to dealing with the challenges of sustainability on the broader stage. Both are dependent on behaviour which takes due account of the long term, including long term relationships, and both rest on behaviour which seeks to avoid waste and to reward efficiency. Whether there will be a flow-back from the increasing demands of sustainability to the profitability of the industry is perhaps more debatable. However, it is undoubtedly the case that growing social and environmental demands associated with sustainable development will make entry to the mining industry an increasingly costly and complex process. Moreover, those without a track record of achievement in social and environmental matters may find it difficult to persuade those controlling access to resources and to the necessary finance to support their undertakings. Such constraints could conceivably have a constructive influence on profitability of the industry to the extent that over-zealousness in the creation of new capacity in the past has been a significant contributor to industry’s poor performance. What the industry cannot afford to do is to submit to the idea that there is an inherent opposition between the interests of mining industry profitability and sustainable development, as is implied in the title of this presentation. Rather, it needs to foster the idea that it is possible to create a coincidence of interests between improved industry profitability and the provisions of sustainable development. The mining industry will need not just to afford sustainable development as a matter of duress, it will need to embrace it on the basis that it is in its own interests,
D. Humphreys / Resources Policy 27 (2001) 1–7
and those of its shareholders, to do so. Ultimately, this is not about costs but about the alignment of mining industry’s values with those of the societies in which it operates. References Tripplett, J.E., Bosworth, B.P., 2000. Productivity in the services sector. Paper to the American Economic Association, January 2000, Boston, MA.
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Metals Economics Group, 1993. Environmental Costs and Issues in Gold Exploration, Halifax, Nova Scotia, July 1993. Metals Economics Group. Corporate Exploration Strategies, Halifax, Nova Scotia, various issues. Statistics Canada, 1997. Environmental Protection Expenditures in the Business Sector, 1996 and 1997 (revised), Ottawa, August 2000. Parry, I.W.H., 1999. Productivity trends in the natural resource industries. In: Simpson, R.D. (Ed.), Productivity in Natural Resource Industries; Improvement through Innovation. Resources for the Future, Washington, DC.
Viewpoint
Sustainable development: can the mining industry afford it?夽 D. Humphreys
*
Rio Tinto Plc, 6 St. James’s Square, London SW1Y 4LD, UK Received 30 January 2001; received in revised form 8 February 2001; accepted 10 February 2001
Abstract Adopting the values of sustainable development implies an increase in the mining industry’s environmental and social costs. For an industry already offering poor returns on capital this is potentially a problem. An examination of the historical record, however, reveals that past increases in environmental and social costs have been more than offset by developments in industry productivity. The emergence of information and communication technologies seems likely to extend this trend into the future. The particular challenges being faced by mining in the US appear to be less to do with rising environmental costs than with competition from countries which have recently opened up to foreign mining investment and to a strong dollar. It seems likely that industry’s adoption of more sustainable practices will require, and could even promote, improved returns to capital in mining. 2001 Elsevier Science Ltd. All rights reserved. Keywords: Mining profitability; Sustainable development; Environmental costs; Productivity; Information and communications technologies; USA
The proposition to be explored in this paper is that the profitability of the mining industry — already poor — is about to get worse as a result of rising cost pressures associated with the social and environmental demands of sustainable development. A secondary objective is to ask whether US miners are set to suffer disproportionately in this process. Profitability and cost pressures It is certainly the case that the financial history of the mining industry is an undistinguished one. As Fig. 1 illustrates, data going back over the past 27 years reveal that the resources sector as a whole has achieved a reasonably respectable 8% average real rate of return on capital. However, this achievement is entirely down to the oil and gas sector which in 1999 had a market capitalisation some eight times that of mining. Real returns for mining have been a much more modest 5%, pos-
夽 This paper is based on a presentation at the Northwest Mining Association’s 106th Annual Meeting, “Winds of Change”, 4–8 December 2000, Spokane, WA, USA. * Tel.: +44-171-930-2399; fax: +44-171-930-3249. E-mail address: [email protected] (D. Humph reys).
Fig. 1.
Profitability by industry sector.
itioning it alongside so-called “basic industries” such as steel, construction, forestry and chemicals. This is the background against which the mining industry now confronts the possibility that cost pressures on it are about to intensify as a result of increased social and environmental demands associated with a move to sustainable development. There is an argument, which generally goes under the heading of “eco-efficiency”, that environmental improvements go hand in hand with improved industry efficiency. In other words, there are “win–win” opport-
0301-4207/01/$ - see front matter 2001 Elsevier Science Ltd. All rights reserved. PII: S 0 3 0 1 - 4 2 0 7 ( 0 1 ) 0 0 0 0 3 - 4
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D. Humphreys / Resources Policy 27 (2001) 1–7
unities which avoid the necessity of making difficult trade-offs between what makes good business sense and what is good for the environment. Higher mineral recoveries obviously mean less waste and lower waste disposal costs, while higher energy efficiencies mean less carbon emissions and lower operating costs. There is undoubtedly much in this argument. However, it is far from the case that all expenditures on social and environmental matters bring about cost-savings. Many such expenditures are a straightforward internalisation of that were previously external costs; which it to say, costs picked up by society at large in the form of the degradation of air or water, or the despoliation of landscapes. The reinforcement of a tailings dam or the sterlisation of part of an ore body for environmental reasons may allow a miner to continue in business but they generate no rates of return. The same applies to the reclamation and rehabilitation of worked-out mine sites. Community programmes are real costs, without necessarily any immediate offsetting efficiencies. So also are the permitting costs which miners must incur before they have cash-flow, always assuming, that is, the permitting process enables them to get one. Quite what the scale of these internalised costs is it is hard to determine. This is partly because some costsavings, of the eco-efficient variety, would have been done anyway, while others are not specifically identified as social and environmental costs but treated as a normal part of doing everyday business. Company accounts do not typically contain headings distinguishing environmental costs, and those identified as social costs will tend only to relate to specific programmes. Were it possible to break out the role of social and environmental costs, they would probably not be that high anyway for the simple reason that many of these activities are today built into the way projects are set up to run. (This will not necessarily be the case at older operations where companies are having to play catchup.) For the most part, it is more likely that additions to costs arising from higher environmental and social standards will be found in the capital component of mine projects. In one of the few attempts to put numbers on these things, Metals Economics Group (1993), in a survey of gold companies in 1993, found that respondents considered environmental provisions accounted, on average, for only 3% of their operating costs. However, they claimed they accounted for around 12% of their feasibility costs and 14% of their development costs, with the figures rising to 22% and 17%, respectively, in more demanding jurisdictions. Data produced by Statistics Canada (1997) show environmental protection accounting for some 23% of capital expenditures in the mining sector and, on a totally different definitional basis (one which includes “any expenditure that ensures or anticipates compliance to environmental regulation or official
voluntary agreement”), for 77% of operating expenditures. But whether incurred in operating or in investment, these are still real costs which make tougher the challenge of an industry seeking to improve its returns on capital.
Productivity and industry returns Against this backdrop, it might seem likely that the arrival of sustainable development as a social objective generally, and as an objective for the mining industry in particular, must, by adding to costs, compromise its profitability further. There are, however, certain problems with this notion. Not the least of these is that the industry has been improving its standards of social and environment performance over very many years already, during which time mining costs have fallen substantially. How is this so? Here we encounter one of the great unsung achievements of the mining industry, its extraordinary and sustained growth in productivity. The record of productivity growth has enabled the industry to offset rising costs associated with the adoption of higher social and environmental standards, combat the tyranny of declining ore grades and, over some periods, still achieve a reduction in real costs of production. Indeed, this decline in real terms production costs is the basis for the long run decline in real prices of many commodities. A particularly fertile source of information on US mining productivity is the US Bureau of the Census. This permits analysis of the mining industry back to 1860. Looking first at its data on copper, it can be seen in Fig. 2 that over the past 140 years, labour productivity per tonne of copper contained in ore has increased at an average rate of 3.4% a year, a total improvement for the period as a whole of over 100 times. Moreover, as indicated by the logarithmic trend, the rate of improvement has been remarkably consistent over the period covered. Considering the productivity of ore milled rather than copper contained in the ore — in many respects a fairer
Fig. 2.
Productivity growth in US copper mining.
D. Humphreys / Resources Policy 27 (2001) 1–7
measure of productivity since it recognises that ore grades have fallen over time — then the productivity growth is around a percentage point higher again. As regards costs, although the trend overall has been down, bearing out the proposition that it is possible to absorb increased social and environmental costs, combat declining grades, and still achieve a reduction in production costs, the experience has varied significantly over different periods. Recession during the 1930s forced a reduction of industry production costs, partly by forcing closures of higher cost capacity, but unit costs subsequently pushed upwards as ore grades declined. Since the early 1980s, real unit costs have fallen sharply, again partly as a result of closures at high cost mines and improvements at the remaining mines producing copper concentrates, but also because of the emergence of a new recovery technology in the form of solvent extractionelectrowinning (SXEW). Similar developments have been experienced in iron ore. Here, as Fig. 3 illustrates, labour productivity has increased at an average rate of 2.5% over the last 140 years; a more modest, though still impressive, 27 times. As in the case of copper, the improvement in productivity has been relatively consistent throughout the period. Also, as with copper, the impacts of these productivity improvements have been slightly less straightforward. The effects of growing economies of scale and then of the Great Depression are evident in the decline of costs through to the 1930s. Thereafter, costs started to rise as the industry was forced to move from direct charge haematite to the upgrading of taconite ores into pellets. Leaving aside the distortions associated with the strike-affected year of 1977 and the recessionary year of 1982, there is the suggestion over the past forty years of a modest decline in the real unit production costs of marketable iron ore in the US. Against the evidence of 140 years, it would be a brave person to claim that opportunities for further productivity improvement in the mining industry have been exhausted. And in fact, at the same time that the mining
Fig. 3.
Productivity growth in US iron ore mining.
3
industry has been shaping up to the demands of sustainable development, so a whole array of new possibilities for improving productivity has arrived in the form of e-technologies, or information and communications technologies (ICTs) as they are more properly known. The contributions of ICT to productivity in mining come about in a rather different way from those associated with much of the earlier productivity growth. Conceptually, production growth flows from one of three sources, capital inputs, labour inputs and total factor productivity. This last element is a measure of the efficiency with which capital and labour inputs, along with intermediate inputs such as purchased services and energy, are used, and incorporates a wide variety of influences such as improvements in embodied technologies, management systems and labour practices as well as the effects of regulatory changes, economies of scale and resource quality. By their nature, these influences are difficult, if not impossible, to measure separately and directly. They manifest themselves statistically as a “residual” after the effects of capital and labour, which are measurable, have been taken into account. For much of the period covered by US Bureau of the Census data, many of the productivity gains achieved are fairly readily traceable to capital injections in the form of better equipment, larger trucks and shovels, improved rail and port infrastructure, and so on. Productivity growth from these capital injections will have been both encouraged and facilitated by two other factors. The first of these is economies of scale, which have permitted the use of larger and more productive equipment. Fig. 4 shows how the proportion of copper produced by mines having a mill capacity of over 10 million tonnes of ore a year has risen from 20% in 1970 to over 70% today. The second factor is energy prices, the decline of which in real terms over extended periods has encouraged capital-labour substitution. Although capital injections will doubtless continue to play a part in industry’s growing productivity, an important — and perhaps increasing — role appears to
Fig. 4.
Share of copper produced by size of mine.
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D. Humphreys / Resources Policy 27 (2001) 1–7
be being played by the influences incorporated into total factor productivity, including ICT. A recent study on productivity growth in the US, although intended to illustrate the problems of output measurement in some of the sectors using ICT most intensively, incidentally drew attention to the remarkable growth in TFP in the mining sector. As Fig. 5 shows, between 1987 and 1997, TFP in mining is estimated to have grown at 4% a year. It is possible, of course, that some special factors applied to the industry over this period. However, they are similar to the results of a study by Ian Parry for Resources for the Future, published in 1999 (Parry, 1999). This showed TFP growth for 1982–1992 of 3.9% for copper mining, 2.6% for coal, 1.3% for petroleum, as against 1.4% for manufacturing as a whole. It is plausible that improvements in ICT in recent times, including most recently the influence of the internet, are underpinning this tendency. The use of ICT in mining is, of course, scarcely new. What is new, however, is that the range of what it can be applied to is being significantly extended. In addition to more traditional areas of ICT application in exploration and operations, ICT is increasingly being used in areas having a less direct, but still important, impact on costs such as integrated business process systems (sometimes know as Enterprise Resource Planning systems), e-procurement systems, as well as shared back-office services and coordinated marketing and shipping. With the assistance of these developments, and of others such as the adoption of low capital processing technologies like heap leaching and bio-oxidation, it seems more than likely that the productivity of the mining industry will continue to grow into the future. These productivity gains will in turn assist the industry to respond to the growing demands imposed on it by sustainable development, as in the past they have enabled it to respond to rising social and environmental costs. A shift in the emphasis of productivity growth in the industry away from capital towards technology and improved work practices also raises interesting questions about the industry’s future capital demands. The valueadding qualities of ICT derive primarily from changes
Fig. 5.
US total factor productivity by sector.
they bring about in the way organisations work rather than from the purchase of big ticket items. Such a switch in emphasis represents a practical response to the charge that the industry has tended to overcapitalise in the past and that this has contributed significantly to the difficulty it has had in delivering satisfactory returns to its shareholders. Or to put it in more familiar terms, the growth in emphasis on ICT and on its role in promoting total factor productivity is consistent with a shift in industry emphasis away from capital spend towards capital efficiency.
A perspective on the US In addition to the general cost implications of growing social and environmental obligations for mining, a second focus for concern is that these costs can vary substantially between different parts of the world and that they may be having a disproportionate impact on miners in some of the more mature economies such as the US. A brief inspection of where exploration expenditures in the industry have been going over the last decade would seem, on the face of it, to support this suggestion (Fig. 6). While exploration expenditure soared through the decade of the 1990s before being hit by the fallout from the Asian Crisis, spend in the US showed only the most modest gains up to 1996 and 1997, all of which (and more) it has subsequently given up. It is self-evidently the case that the cumulative effect of environmental regulations makes life tough for miners in the US. But this is the fate of many basic industries located in rich countries which feel they have the choice over whether or not they continue to need to host such activities. The situation is little different in Europe where miners are generally subject to environmental conditions as tough as those in the US and where competition for space from alternative land uses is probably even more acute. There is, however, another dimension to this issue,
Fig. 6.
Industry exploration expenditure by region.
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which is that the US has a clear and workable system of laws which, while they may be tough, nevertheless provides reasonable conditions of certainty for the businesses subject to them. In addition, the US offers political stability, an educated workforce, a functional and predictable tax system, good infrastructure and sophisticated health and welfare support. By contrast, in some of the developing countries in which mining companies operate, considerations of sustainable development bring within them obligations to consider a much wider range of social commitments than is the case in the US. These may cover education and health, programmes for promoting local economic activities, support for indigenous peoples, and even basic institution building. These all come at a cost to the companies, a cost which in the US can be shared with a wide range of other contributors. In many developing countries they have to shoulder them on their own. Moreover, while environmental laws may or may not be formally as stringent as in the US, companies cannot risk adopting standards which are lower and which may become unacceptable in a few years time. There are inevitably uncertainties about such judgements. However, in surveys of what drives investment decisions on investment behaviour in the mining industry, the stringency of environmental regulation generally comes some way down the list of considerations of concern, and a long way after such matters as security of legal tenure, political stability, and the ability to repatriate profits. For the reasons behind the poor performance of the US in the world exploration league over the past decade it is necessary to look elsewhere. The first point of note is that political changes elsewhere in the world have led to a widespread opening up of opportunities in countries previously off limits to overseas mining investors. Throughout Latin America, Asia and Africa, the end of the Cold War and the rolling back of the state have led country after country to seek to position themselves to benefit from an inward flow of private mining capital. Over 100 countries have re-written their mining laws since 1985. The US, Australia and Canada benefited relatively in exploration through much of the 1980s from the fact that most other countries looked too difficult. More specifically, they also benefited from the development of new gold provinces, a high gold price and some favourable tax provisions. In the 1990s that changed, and while the US may have lost out relatively, generally mining and exploration activity thrived. The switch of investment away from the US, and also to a lesser degree Canada and Australia, was motivated by the conviction that here was a once-for-all opportunity for mining companies that they could not afford to pass up. It cannot be viewed simply as an expression of disenchantment with investment conditions in these three countries.
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Fig. 7. Copper breakeven production costs.
The second factor drawing mining investment away from the US is a simple piece of economics. The success of the new economy in the US and the high flow of funds into the US chasing new economy investments led to a strong US dollar. Already a high wage economy, this has made the US a tough place for basic commodity businesses in which branding and patenting offer little, if any, scope for producers to protect their margins in a highly competitive international market. The point can be made by looking at the trend in cash costs for copper production over two or three decades. As can be seen from Fig. 7, the US copper industry has dramatically reduced its production costs since the early 1980s. Average cash breakeven costs have effectively been halved in real dollar terms over this period. This has been accomplished partly by the closure by high cost capacity, and partly by cost reductions at existing operations and by the growth of SXEW production. While it may well have been the case that the prospect of having to make significant expenditures to remain environmentally compliant was a contributory factor in some of these mine closures, it is unlikely to have been the determining factor where mines otherwise had the potential to remain competitive. These changes have enabled US miners to close the gap on producers elsewhere in cost terms. Despite this, the US remains a relatively high cost producer in world terms. Fig. 8 chart sheds some light on why US miners have
Fig. 8.
Copper costs and the US dollar.
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struggled to maintain international competitiveness in spite of these achievements. In this figure, US copper mine costs are shown as a ratio of average copper mine costs outside the US. (In contrast to the chart above, costs are here presented on a pro rata basis to suppress the complicating impacts of by-product credits on underlying copper costs.) It also shows the US dollar’s effective exchange rate over the same period. The effect of high dollar values on the international competitiveness of the US copper industry during the mid-1980s is apparent. So also is the diminishing competitiveness of the industry through the second half of the 1990s as the dollar went through another period of strength. The US may have the highest productivity levels in the world but it is a big ask for the industry to outperform the rest of world’s industry to the extent necessary to compensate fully for these currency effects.
Sustainable development and industry returns: a coincidence of interests To return now to the question posed by the title of the paper, “sustainable development: can the industry afford it?” In a sense, this is a non question. The industry is going to have to address the demands of sustainable development and it is going to have to afford it. Society has been clearly signalling to the industry that the traditional ways of doing things will simply not be acceptable in the future. The only meaningful question to be addressed is how the industry intends to respond. Some aspects of the way in which the industry seeks to internalise the values of sustainable development will have a material cost impact and the industry will have to be looking to ways to offset these costs through productivity growth, as it has done in the past. Consistency with their economic objectives suggests that, in seeking to boost their productivity, companies will increasingly favour low capital solutions. Other aspects may have less to do with spending money than with a more enlightened management of industry’s relationships with the public, with NGOs, with local governments and customers. More than ever, the industry cannot afford the tensions and disruptions associated with unhappy neighbours, not to mention any resulting litigation. Nor can it afford to bank on the unquestioning support of a financial community which is becoming more nervous about funding natural resource developments because of negative public perceptions. Access to resources and to the finance to bring them to production are the life-blood of the mining industry and to achieve and sustain such access the industry needs public understanding and support, not just legal approvals. Formal permitting is, and will remain critically important to the industry, but it will not buy a company a social right to operate. In short, the industry can-
not afford not to sign up to the values of sustainable development and to live out these values in practice. There is simply too much at stake. Having to absorb the costs associated with the transition to sustainable development is one thing, doing so in a positive and profitable way is quite another. Which brings us back to the issue raised at the beginning of this presentation; the poor long run profitability of the mining industry. The roots to this problem are largely independent of considerations of social and environmental costs. Although the subject of another paper, a strong case exists for believing that the problem of poor returns is a product of industry’s own economic behaviour, specifically its tendency to over optimism on demand, over investment in new capacity and over capitalisation of that capacity. That said, the achievement of improved rates of return on capital is not unrelated to industry’s ability to deal constructively with the challenges of sustainable development. Indeed the two are intimately related. A more profitable industry will clearly be better able to respond to the growing demands of sustainable development. More than that, an industry which is more focused on the sustainability of its own activities will be better attuned to dealing with the challenges of sustainability on the broader stage. Both are dependent on behaviour which takes due account of the long term, including long term relationships, and both rest on behaviour which seeks to avoid waste and to reward efficiency. Whether there will be a flow-back from the increasing demands of sustainability to the profitability of the industry is perhaps more debatable. However, it is undoubtedly the case that growing social and environmental demands associated with sustainable development will make entry to the mining industry an increasingly costly and complex process. Moreover, those without a track record of achievement in social and environmental matters may find it difficult to persuade those controlling access to resources and to the necessary finance to support their undertakings. Such constraints could conceivably have a constructive influence on profitability of the industry to the extent that over-zealousness in the creation of new capacity in the past has been a significant contributor to industry’s poor performance. What the industry cannot afford to do is to submit to the idea that there is an inherent opposition between the interests of mining industry profitability and sustainable development, as is implied in the title of this presentation. Rather, it needs to foster the idea that it is possible to create a coincidence of interests between improved industry profitability and the provisions of sustainable development. The mining industry will need not just to afford sustainable development as a matter of duress, it will need to embrace it on the basis that it is in its own interests,
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and those of its shareholders, to do so. Ultimately, this is not about costs but about the alignment of mining industry’s values with those of the societies in which it operates. References Tripplett, J.E., Bosworth, B.P., 2000. Productivity in the services sector. Paper to the American Economic Association, January 2000, Boston, MA.
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Metals Economics Group, 1993. Environmental Costs and Issues in Gold Exploration, Halifax, Nova Scotia, July 1993. Metals Economics Group. Corporate Exploration Strategies, Halifax, Nova Scotia, various issues. Statistics Canada, 1997. Environmental Protection Expenditures in the Business Sector, 1996 and 1997 (revised), Ottawa, August 2000. Parry, I.W.H., 1999. Productivity trends in the natural resource industries. In: Simpson, R.D. (Ed.), Productivity in Natural Resource Industries; Improvement through Innovation. Resources for the Future, Washington, DC.