It's official: Mining is suffering an investment strike
South Africa’s miners are unwilling to risk capital and are on an investment strike. After adjusting for inflation, using StatsSA data, capital expenditure is estimated to be half of 2008’s levels – an 8% annual decline in real terms. This is in stark contrast to 2005-08 when it more than doubled.
Instead of incentivising investment and growth, the Mineral and Petroleum Development Act (MPRDA) and new mining charter has created uncertainty and hostility. Therefore, although prices are picking up, we will continue to see lethargy. Piled on top of negative policies, it appears that our mines are facing a productivity problem with labour output and capital effectiveness on the decline.
The slowdown in spending is reflected in the national capital expenditure to depreciation ratio. When this ratio is above 1 it indicates that organisations are spending over and above replacement needs, suggesting expansion. However, when that number drops below 1, it signals that companies are only looking to maintain (or run down) their assets.
In early 2016, the ratio fell to 0,8. It would have been below one sooner, but the lag of committed capital from old projects held it higher. It is, therefore, probable that the descent will continue.
Figure 1 - Index of Capital Expenditure in Real terms (after adjusting for inflation) and Capital Expenditure to Depreciation Ratio. Source: StatsSA and Chamber of Mines
Prices have contributed, but even with an average 26% recovery in prices from 2009-12, there was no increase in CapEx. We think uncertainty and red tape, along with productivity issues, are crippling the motivation to invest. If the market continues to improve, South Africa is set to miss out.
Thankfully, change is within reach, and there are possible actions to reverse the investment strike.
An unwelcome policy environment
Investors are placing a risk premium on South African mining. The amendments to the MPRDA are almost dictatorial. It gives the Minister powerful decision rights, including setting pricing and imposing export permits. This not only opens it up to corruption but makes for a frightful investment setting. How can an investor create a financial case when they are unsure of what price to use or market to target? These factors will be dependent solely on the mining minister. Investors are forced to demand higher returns for that risk, or simply invest elsewhere.
The mining charter has followed a similar path. Miners feel their comments were completely ignored in the latest draft. In particular, the perpetual 26% black-owned requirement is frustrating. Although laudable, it is financially and administratively impractical for both parties. Miners would have to monitor continually and fund new share issues. On the black shareholder side, they may face selling restrictions and ultimately, end up with B-class illiquid shares.
This is not the only concern, though, with onerous expectations on procurement to classify “BEE-Compliant Companies”. The need for transformation and skills development is important, but blunt and uncertain laws will hinder any investment to fund that change. All this adds to governance costs and acts as another tax on the business, as well as a hurdle to future investment decisions.
The delay in finalising these new policies, and the inherent instability in the laws themselves, create that investor-repelling uncertainty in South African mining.
Productivity continues to decline
Falling labour productivity and rising costs are undermining returns. The average unit output per employee has fallen by 11% since 2005, against a colossal 193% increase in employee earnings. Labour productivity has a critical relationship with capital, though- 5 labourers with 1 spade will be far less effective than 5 labourers with 5 spades (5 labourers with 10 spades is also less effective).
DBA’s index of capital productivity suffered a 43% drop since 2005, despite an increase in capital per employee. We suspect this is due to capital investment choices – refurbishing equipment and not overhauling production methods. The move to automation has been slow and inconsistent. Miners seem to be fixing spades instead of buying a digger.
A shift in productivity is required, and miners need to consider new ways of operating. However, it requires major investment to realise this, and there is hardly any regulatory encouragement for it.
The way forward
There are options to rescue the situation. Investors are desperate for consistency and welcoming rhetoric. Legislation must be truly consultative, practical and recognise that we operate in a globally competitive industry, fighting for every piece of investment.
We recommend simplifying, relying on incentives, and using data to monitor. Time is not on South Africa's side; this work needs to be completed urgently to create certainty. Worryingly, analysts are expecting a more populist stance from the ANC in light of their less than ideal election results.
For the private sector, continue government consultation but also look to optimise capital portfolios and have a serious introspection of operations. Improve how capital is allocated and managed, fixing the internal systems so that they extract more value from individual, essential projects.
The second avenue is a more serious transformation of operations. At the macro level, constraints often prevent higher productivity. Large miners need to have a deep review of their pit-to-port supply chain and consider how they are balancing the constraints at each asset.
At the mine level, businesses need to innovate aggressively and investigate how they can introduce new technology to make step changes to production.
These changes won’t be cheap and they won't be easy, but if we want to see a change from the previous decade of stalling investment, they must be implemented.