Mining 2016: Roundtable

Carlos Vilhena: We are still pretty busy, but the kind of work we have been doing over the past 12 months has changed. We saw a reduction in M&A and new investment-type work. There has been a shift to legal assistance involved in the renegotiation of debt, refinancing and restructure of operations. We have also helped clients with legal matters relating to suspension of operations, putting assets in care and maintenance, and the consequences arising therefrom. Discussion of the new Brazilian mining law in our National Congress has also kept us very busy, but this is obviously unique to Brazil.

Luis Carlos Rodrigo Prado: The significant reduction in price of almost all minerals and metals has certainly had an impact on the industry. On the one hand, junior companies have ceased to be a dynamic sector and financing for their projects is very difficult to find. On the other hand, medium-sized and major companies are also experiencing the effects of this situation, trying desperately to reduce costs and be more efficient every day. In Peru, mining activities remain an essential part of our economy, but this market of low-commodity prices has contributed to the slowdown of our economy. Despite this, and with Peru being a true “mining country”, several important projects that began before the “crisis” continue, such as, among others, Minmetals’ US$7 billion Las Bambas project; the US$5 billion expansion of Freeport’s Cerro Verde production unit; and the recently inaugurated Toromocho mine operated by Chinalco, which is undertaking an expansion of its production capacity with a total investment of around US$5 billion.

Fortunately for me and my firm, these three companies are good clients and, therefore, we continue to have intense activity. Likewise, longstanding clients such as Antamina and Southern Copper Corp also provide significant activity for us, as do Hudbay Minerals and its recently completed Constancia mine. Besides this, there are some advanced exploration projects that are still very active for us, such as Anglo American’s Quellaveco project. On the other hand, we have also had a more active year in M&A and financings than we expected – having, for example, advised Tahoe Resources in the US$1.3 billion acquisition of Río Alto and Sulliden, as well as Teck Corporation in the streaming agreement entered into with Franco Nevada regarding Antamina’s silver production, among other relevant transactions. Therefore, fortunately for us, in the past 12 months we have been involved in the most relevant investments, acquisitions and financings that have taken place (or are taking place) in Peru, but I would say this is an exception; our intense activity does not reflect the fact that the market has, undoubtedly, slowed down.

Our main concern is what is going to happen in two or three years, when all the ongoing investments, and the projects that should start being built in the near future, are completed, because the clear impact that this depressed market is having on exploration activities is a pipeline of projects that is not growing as it should be.

Darrell Podowski: In Canada the falling demand and oversupply of the major commodities has created a slow economic environment for the exploration, development and production of mineral resources. Deal activity therefore has materially been reduced for a number of reasons, including the following:

Risk aversion among resource companies as well as investors. Financing has become a much more challenging process. The biggest losers are in the exploration sector as a result of a total lack of public risk equity and a preference for producing or near-producing assets.

An acute focus on return on capital employed.
A major focus on internal growth through existing brownfield projects, rather than looking for external growth opportunities.
There appears to be an M&A malaise. There is an increased perception that M&A is value-destructive. In addition, there appears to be little appetite for mega-deals.
Access to debt capital markets is limited to high-grade producers only.
Absence of equity risk capital.
Senior producers focused on near-term operational improvements and debt reduction, with little or no appetite to finance new projects.
Investors have become much more selective in their willingness to deploy and invest capital.

Therefore this year, and we expect over the next year, activity in the mineral resource sector has been, and will be, focused on the following:

Assisting companies with financing structures that are often obtained from multiple providers and structures including high-yield debt, streaming transactions, offtake transactions and equity.
Distress selling: sales of assets and cash-flow streams to reduce debt levels or for badly needed maintenance or expansion capital that can often compromise future earnings.
Portfolio optimisation: senior companies continue to review and attempt to optimise their operations by divesting “non-core” assets and operations through sales, streams, spin-outs and joint ventures.
Selective M&A for advanced juniors and single-project developers.
Joint ventures between companies combining neighbouring projects under a common joint venture to take advantage of synergies and costs savings in developing such projects.

Peter Leon: In South Africa, the falling demand and oversupply of the major commodities in the market have affected the mining sector in a number of ways. Declining commodity prices, labour issues around job losses and strikes, regulatory uncertainty as well as the threat of further sovereign credit downgrades, have created something of a “perfect storm” for the South African mining industry.

Coal maintained its strong position as the leading South African mining commodity revenue generator, despite a continued reduction in prices. Platinum group metals grew off a low base due to the prolonged strike by platinum workers experienced in 2014. The decrease in the rand-value of platinum group metals experienced in 2014 somewhat offset any benefit from the increased production volumes. As expected, owing to the low iron ore price, there was a substantial decrease in iron ore’s share of mining revenues despite good production levels.

Mining companies in South Africa are obviously focusing on cost-reduction strategies and have taken steps to consolidate their existing assets, while disposing of unproductive assets. With some 50 per cent of the mining sector operating below par, mining companies have felt the impact of adverse market conditions on their share prices.

Today, mining companies constitute a mere 10 per cent of the Johannesburg Stock Exchange (JSE) All Share Index, down from 50 per cent in 2012 and 80 per cent in the 1960s. Furthermore, the 19 per cent decrease in the JSE mining index from June 2012 to September 2014 spilled over into the following 12 months; the mining index fell by over 37 per cent between September 2014 and September 2015. Each of the JSE’s top 10 mining companies by market capitalisation saw falls in share price over the last year.

The mineral resources sector contributes some 8 per cent to South Africa’s GDP directly and 17 per cent indirectly; it is the country’s second-largest employer, with an estimated 14 per cent of total employment. These figures indicate the importance and value of the mining industry to South Africa. However, exogenous and endogenous factors affecting the industry have had a significant effect on the domestic economy, given the centrality of mining to South Africa’s exports and thus on the balance of payments.

The firm’s mining practice has experienced a downturn in M&A activity within the sector and has responded to this by focusing on disposals, restructurings (debt and corporate), business rescue and regulatory work. Current regulatory issues within the mining sector have resulted in significantly increased regulatory work.

Describe the current financing situation for mining projects in your jurisdiction. What options are available?

Carlos Vilhena: Financing is tight, as it is in most other places. Juniors have been hit really hard and have almost disappeared. We did work in refinancing and debt restructure, but very few new financings. We did see a small amount of streaming deals.

Luis Carlos Rodrigo Prado: Financing is certainly very difficult to obtain these days. This situation has had a severe impact on the junior sector and there are only a handful of junior companies that are able to move forward with their projects, most of them supported by private equity funding, which is something we are seeing more and more in Peru. On the other hand, the more typical credit or bank financing is only available for some very well-established companies (for example, we recently participated in the syndicated credit facility for Cerro Verde in connection with its US$5 billion expansion). Because of this, what we are seeing more and more is the use of “streaming” arrangements as a way to obtain financing. We have participated in this type of transaction, representing Hudbay Minerals in their agreement with Silver Wheaton and on the one that Teck Corporation has just completed with Franco Nevada regarding the former’s share of Antamina’s silver production.

We have also worked on the US$2 billion international bond issue that Southern Copper Corporation made in the first semester of this year, but it is clear that this type of financing mechanism is again only available for very established companies. Local bonds issues by mining companies were very common just a few years ago, but they have certainly slowed down very dramatically in these last months.

IPOs in the Lima Stock Excahnge by mining companies are also very rare, due to the material reduction in share prices of all mining shares and we do not expect too much activity on this front in the near future.

Darrell Podowski:The traditional source of funding of mineral exploration and development companies in Canada has been the public capital markets, but for most, the public equity capital markets are largely unavailable in the current market environment. For those who are able to access the public equity capital markets, equity issuances will likely be very expensive and dilutive, and an option of last resort. Therefore mineral exploration and mining companies are having to conserve capital and spend it wisely until raising capital in the public markets becomes viable again. As a result companies in Canada are forced to consider other financing options such as private equity, convertible debt, high-yield debt, syndicated bank financings, streaming arrangements and royalty sales.

Peter Leon: The mining industry downturn has created challenging conditions for mining companies to access capital in South Africa. Investors are beginning to attach a risk premium to South African mining investments. This has had the effect of increasing the cost of capital for South African mining companies. Some companies have moved to separate their South African assets from their global assets, to assist them in raising capital for their international investments. In some cases, this can leave their South African assets cash-constrained and struggling to fund expansion projects.

Although black economic empowerment (BEE) transactions are often vendor financed, there has been some movement away from regular institutional financing to developmental finance institutions, such as the Industrial Development Corporation and the Development Bank of Southern Africa.

In the last year investment in the mining sector principally emanated from greenfield projects and companies rationalising or restructuring their assets to decrease their operating costs.

Regulatory uncertainty and somewhat volatile labour conditions in South Africa have increased the country’s operating risk. Compounded by increasing pressures from rising costs, mining companies find that producing more is not necessarily more profitable. Mining companies have consequently increased their internal requirements for project profitability, abandoning projects that do not promise high enough returns.

Commodity prices were at their lowest in August 2015 since 1999, yet zinc is emerging as an exception. Are there any pockets of activity in your jurisdiction? What opportunities currently exist in the market?

Carlos Vilhena: Brazil’s mining GDP is largely iron ore-based. The prices of such commodities have had an effect throughout the mining industry – not just on the iron ore companies – but also on suppliers and contractors. On the other hand, the significant decrease in commodity prices, and the strong devaluation of Brazil’s currency, mean that assets are cheaper and this may be an opportunity for capitalised companies. In fact, we have recently been seeing more interest from investors assessing Brazilian assets for potential acquisition or investment.

Luis Carlos Rodrigo Prado: Peru is geologically very gifted and has a very diverse production (copper, lead, zinc, molybdenum, gold, silver, tin, iron, etc). Throughout the years, zinc has been one of the most relevant minerals produced in the country (by Volcan, Antamina, Milpo, SIMSA and many other producers). Recently, zinc has been one of the main hopes during this commodity price crisis, but it still has not “exploded”, with many projects still on hold. For the near future, projects related to copper and, to a lesser degree, gold continue to be the most advanced and interesting for investors in the country. However, there are very important zinc projects (such as San Gergorio, owned by Sociedad Minera El Brocal SAA) which are world-class projects. If prices remain as they are, these zinc projects will probably gain more importance and support to be built.

Darrell Podowski: From a Canadian perspective there are no obvious pockets of activity. Gold-related activity will always fluctuate as the price moves up and down due to world economic events, which will result in windows of opportunity to raise capital. Other areas of activity will be directly driven by a rise in commodity prices, which is something none of us can predict. Uranium is also hard to predict, especially with the volatility in oil and gas prices.

Peter Leon: The profit margins for zinc miners are expected to increase over the next five years as a result of price increases owing to global demand for zinc exceeding supply. The overall strong-demand growth, low supply and falling stockpiles indicate a positive outlook for zinc as financing zinc projects continues to be a priority for funding institutions.

The most recent pocket of activity in relation to zinc in South Africa is the announcement by Vedanta plc of the opening of a new zinc mine in the Northern Cape province, South Africa. Vedanta has indicated that it plans to turn the Southern African region into one of the most important suppliers of zinc worldwide, and has announced that it will invest US$782 million over three years in building this new mine, known as the Gamsberg zinc mine, and situated just east of Aggeneys in the Northern Cape. This new mine will not only boost zinc production in South Africa, but also assist in job creation, as opposed to the current wave of labour shedding.

Stakeholders are increasingly vocal in their demands from the industry. How has this affected mining companies from a legal standpoint?

Carlos Vilhena: The industry, in my view, has in most cases, reacted well and been able to accommodate demands fairly. The level of understanding of stakeholders in different jurisdictions, and even within a country the size of Brazil, can vary immensely. So companies that are better equipped to deal with such reality have an advantage. Legal practitioners have a vital role in this process and must be prepared to deal with the different legal matters arising therefrom. In the specific case of Brazil we have seen various demands arising within the context of the new mining law discussion in Congress. The low commodity price cycles have dramatically changed the approach of mining companies to demands, simply because there is much less spare money available. Being at the centre of this discussion has been extremely interesting.

Luis Carlos Rodrigo Prado: Mining has a negative past (with a long history of contamination issues and claims that it has not contributed to the development of the areas where mining operations take place). Being a country with a long mining history, Peru has a number of environmentally sensitive legacies from past mining operations and even today the illegal mining activities are creating a significant environmental tragedy in some areas (Madre de Dios, Tambogrande, etc). The mining industry has changed and in the last few decades it has clearly understood the need to be environmentally and socially responsible, as well as to contribute directly (and not only through taxes and similar contributions) to the wellbeing of the people living in the areas of influence of the projects. In Peru we also have incredibly successful stories of this important contribution to the development of mining areas (Toquepala, the areas around Antamina, etc), but still the industry shies away from undertaking a creative and effective communications strategy and, therefore, continues to face significant opposition in many areas of the country. These efforts are very well organised by political parties (leftist anti-mining parties) as well as by local and international NGOs, which are very well financed and manipulate the population against mining activities. This is what we have seen in Conga (US$5 billion project owned by Newmont, stopped a few years ago), Tía María (owned by Southern Copper Corp and stopped recently), as well as in the US$7 billion Las Bambas project (which is 95 per cent built and is now facing this strategic manipulation by leftist parties).

It is true that companies could be doing more, but the fact is that they have contributed billions of dollars that have been, and now are, in the hands (or bank accounts) of the regional and local governments of those areas, who have been unable to invest in them to create the infrastructure, and education and health programmes that would make people feel the benefits of mining. In short, in some areas people support and want mining; in others, especially where public investments in infrastucture have not been made (either due to corruption – there are five regional governors in jail right now – or a lack of capacity on the part of authorities), opposition is significant. With general elections approaching (April 2016), and mining always a big part of the debate, it is probable that more publicised opposition will continue to exist in the coming months. However, Peru requires mining investment to continue growing and, therefore, the important challenge is to make sure that projects are developed in the most environmentally and socially responsible way by first-class companies, and that we really fight against illegal mining.

Darrell Podowski: Stakeholder demands and activities have increasingly affected mineral exploration and mining companies in Canada by having to engage and consult with various groups, such as aboriginal or First Nation groups, community groups and environmental groups. In Canada the consultation process with aboriginal peoples, to explore for and mine minerals, has added another layer of complexity in the permitting process to build a mine. Also in 2014, the Supreme Court of Canada issued a historic decision declaring that aboriginal title exists in certain defined areas in British Columbia. It is still not certain how that decision will affect other areas of British Columbia or Canada, but resource companies will need to be aware of this recognition by the courts of aboriginal title when entering into areas of Canada where aboriginal peoples occupy and use lands, and use water.

From a legal standpoint this increasing stakeholder participation has resulted in changes to the landscape of exploring for minerals and building a mine. These changes include:

requiring companies to have a social licence to operate;
resource nationalism becoming an increasingly hot topic in many jurisdictions where Canadian companies explore for minerals and build mines;
shared ownership of infrastructure with stakeholders increasingly being implemented in structuring transactions;
sharing the benefits with stakeholders such as suppliers, governments, communities, employees and aboriginals;
governance structures being adjusted to accommodate stakeholder participation; and
transparency and accountability of mining companies significantly increasing.

Peter Leon: The current state of the mining industry has resulted in mining companies having to balance the needs of multiple stakeholders. A combination of regulatory uncertainty, labour issues and declining commodity prices has resulted in mining companies becoming much more focused on equity returns and cost-containment.

On the regulatory front, this has led mining companies to become far more vocal in their views on policy and regulation and challenging regulatory decisions which affect their bottom line. A standout example of this is the unprecedented decision of the Chamber of Mines to bring a court challenge to interpretative aspects of the Mining Charter, which will be heard in the Pretoria High Court in the first half of next year.

Labour issues continue to be an issue for the South African mining industry. Organised labour has been vocal around the bargaining table with mining companies this year, in the wake of last year’s platinum sector strike led by the majority trade union, the Association of Mineworkers’ and Construction Union (AMCU). Last year’s strike saw a 40 per cent fall in the global production of platinum, of which South Africa is the world’s biggest producer. Employees’ demands continue to be a challenge for employers at a time of declining prices and increased costs, which have not been offset by the ongoing depreciation of the South African rand.

Labour issues remain a huge challenge for mining companies in the absence of a binding social compact between government, labour and business. The government will try to address this in November’s Mining Phakisa Laboratory, which aims to put the industry on a better long-term trajectory through binding commitments to turn around the industry by government, labour and business.

As a precursor to this, the Mining Industry Growth Development and Employment Task Team (MIGDETT), comprising all three stakeholders, signed a Leaders’ Declaration on 31 August 2015. In this, the stakeholders undertook to address employment challenges facing the sector and to identify short, medium and long-term interventions in the industry.