Monday, February 13, 2017

Riding the Boom and Bust in the Resources Industry

Will the next mining boom help or hinder our efforts to innovate and transform?

Last December, I wrote a short post on LinkedIn to point out that commodity prices seem to be bouncing back in a concerted way that may indicate the start of another resources boom.  I wondered whether that was this "Another dead cat bounce, or has the worm turned for mining? The latest RBA commodity price index has the weighted average (by value) of the prices for Australia's commodity sector clawing back to above the depths it sunk to post GFC".  (Note: RBA = Reserve Bank of Australia and GFC = Global Financial Crisis.)

The trend has continued since then, and we've now had seven consecutive monthly rises in the RBA commodity price index.  The latest version of this index (incorporating data up to end March 2017) shows the prices rising across all of the resource bulk commodities (iron ore, met coal, thermal coal, base metals, oil&gas).  In fact in the last 4 months the index has risen as fast as it did during the pre and post GFC periods, shown as two peaks on the following graph.  The index is now higher than it was at any time before mid 2008.

I've often used this index to illustrate price trends since it smoothes out much of the noise seen in the trends for the individual commodities.  The log scale also helps to take the focus away from the extreme peaks and allows exponential rates to be seen as straight lines.

If this trend continues through 2017, then we are definitely back into a resources boom.  Increased prices lead to increased profits (and taxes) which lead to increased investment in production expansion.  In addition, since we are now exporting more of these commodities than ever before, the value to the Australian economy is such that the current account deficit has turned around and is moving towards parity in the value of imports versus exports.

The economic impact in Australia of the previous boom was fairly obvious, and it has been widely accepted as the main reason for the lack of any serious post-GFC recession in Australia.  This is explained in detail in a study by the RBA published in December 2014, which shows that the impact extended across a range of economic indicators (household income, exchange rates, unemployment, inflation, interest rates).  This economic impact was predicted to have a positive effect well into the future even if prices remain low.

So despite several years of pundits and politicians claiming that the mining boom is over and that we need to transition our economy to new industries, we may now get back to the "good times".  The risk is that investment and capital spending will escalate and everyone will forget about all belt tightening and diversification.  Companies and governments will jump back on the gravy train and the resulting expansions in production will thereby set up the conditions for the future oversupply in the market and so giving rise to another bust.

Btw, I'm not saying the boom is definitely back, and in fact my previous predictions of the inevitable return of a resources boom have proven to be premature.  On one hand, long term demand trend for basic bulk commodities has to be onwards and upwards due to the continued growth in population and urbanisation in China, India and Brazil in particular.  On the other hand, the short term demand trend has been very flat in recent years, and there have been many explanations for the current price turnaround that suggest it may be only temporary, for example in recent news articles that quote the Citi Group.

My main point is that regardless of what happens this year, the underlying demand curve dictates that the boom has to come back sometime and this will inevitably lead to another bust.  The commodity boom and bust cycle has been evident since the industrial revolution, but has become much more extreme and much less predictable in the last 10 years than in previous decades.   This is inevitable when nobody is planning for any longer than two or three years.  In supply chain circles this boom and bust cycle is called the Bullwhip Effect due to how quickly the transitions occur.

This cycle has had the effect of disrupting long term efforts in improving the capability in the industry to make systemic change and hence transform to better ways of working.  The net result has been declining productivity, largely through having mined the best parts of the best orebodies without adequate replacement through exploration discovery.

Regardless of whether we're in a long bust or locked in a boom and bust cycle, they both add to a poor public perception of the mining industry.  Instead of a vibrant industry that is seen as smart, safe and sustainable, we have a widespread public perception that it's dumb, dangerous and dead!

I'm reminded of a talk given by Professor Bruce Hebblewhite  at the 1st Future Mining Conference at University of NSW in November 2008, where he argued that one of the biggest issues facing the industry was the "chronic shortage of skilled employees to serve both the needs of this industry growth, as well as replacement of what is typically an ageing workforce".  At the time, I had also been involved in a number of activities around addressing this issue, not just from an education perspective, but also from a knowledge management perspective aimed at making better use of available expertise and learning from both successes and failures in innovation.

This conference was held right at the peak of the initial boom and while the GFC had hit the financial markets in early 2008, it was not until the very end of 2008 that we saw a crash in the commodity prices.  As the history in the above graph shows, the GFC simply burst a short term commodity price bubble and it was less than 2 years before prices came back stronger than before.  So the trend can be described as essentially a long boom between 2003 and 2011, albeit with a pretty big speed bump.  Since then we've been in a long bust, perhaps with another speed bump happening right now.

During this bust, all of the activities around addressing the shortage of expertise lost momentum very quickly once it was obvious that more people were being retired or laid off than were being hired.  Many of those laid off by mining companies went into consulting and other services, so for a while there was no shortage of available expertise for almost any purpose.  The constant cost-cutting initiatives by the mining companies over the last 5 years have also led to significant job losses in the services companies.

I don't think the causes of the downturn since 2011 have been adequately explained, but it's clear that the shear number and size of the expansion projects during the boom have caused the bust to be much longer than anyone anticipated.  The 4-5 year lag between planning and first ore production means that we've been adding product to a depressed market in unprecedented volumes.  Perhaps the excess production has now been adsorbed, particularly for higher quality ores.

Professor Hebblewhite also said in 2008 that the problem for the research sector is that the mining industry has Alzheimer's Disease and keeps forgetting what has happened in the past.  The universities struggle with meeting the changing industry demand for graduates in this boom and bust cycle, since they also have a 4-5 year lag in responding to changing demand.  Just ask any head of a university Mining Engineering Department about how many new students enrolled in 2016 and 2017.

Mining Engineering graduates are like the "canary in the mine" since their only industry career path is mining.  With something like a tenth of the intake in boom times, I say good luck to those few students who have taken the plunge when almost everyone of influence was saying the industry was dead and buried).  They will likely graduate in a time of high demand for young mining engineers.

So it's not hard to predict that if the boom is back, there's going to be a lot of complaining about a chronic shortage of skills.  I expect it's going to be worst this time, because the length of the recent downturn will have driven many people from the industry permanently, particularly those who chose early retirement when they were laid off.  Others will have swapped careers and may not be tempted to return to such a volatile industry.  There will be some who have chosen to use the time to up-skill through post-graduate study and they will definitely gain from any turn-around in the market.  There will also be a migration from services companies back into mining companies.  The overall capability in the industry, however, will be significantly less than it was during the last boom, particularly in regards to people with an ability to innovate and implement change.

As we saw in the previous boom, the churn created by competition for expertise will disrupt the long term research and innovation programs in both industry and universities.  In addition, the change in the focus in innovation investment from topics relevant to cost cutting to topics relevant production expansion will also have a disruptive effect.  Much of the current research and development being conducted by mining service companies (the METS sector) will also be impacted by a loss of expertise and a changing innovation focus by their clients.  When mining companies change their focus, the existing research projects get stranded as the attention turns to other topics and hence moves to other research partners, who are then in direct competition with mining companies for the required expertise.

Some research and innovation areas will be able to readily adapt, for example the application of remote operations, advanced analytics and mobile solutions, since they first started to take off in 2007, so had already proven their worth in both boom and bust market conditions.  Nevertheless, demand for experts with both deep domain knowledge and technology skills will lead to problems in achieving success in these applications.  That is, expertise will be sought without this "double deep" capability and this will then lead to poorly defined and executed initiatives.  In addition, the limited pool of the best expertise will see a lot of churn as they get attracted into new jobs and have to start over.

There are also a lot of other issues that restrict the mining industry from developing the capability it needs to transform itself to a more modern digital future, and I gave a long list of these in an article in March last year, when I posed: Are we ready for the brave new world in mining?

This brave new world of the "Next Generation, Network Centric, Smart Mine of the Future" will come to pass regardless of the commodity price cycles, since the fundamental challenges for the mining industry are around deeper and lower grade ores, community demands for more sustainable operations, remote and complex supply chains, and (of course) the lack of expertise for both planning and execution of the required transformations.

I'm not confident that new innovation investment driven by a new boom will be wisely directed.  I am, however, hopeful that a turnaround will lead to more attention to how we as an industry and we as a nation can make sustained long term progress.  That is, progress in a way that can ride the roller coaster of this commodity price cycle.

Since most people in positions of influence have been saying for years that the boom is over, then they will get a surprise when it comes back strongly.  Their only excuse will be to admit that it's part of a macro-economic cycle.  So this may help get some attention on the systemic challenges around building sustained public and private capability to innovate and transform.

Rather than start from scratch, we should just dust off all the analysis and recommendations from a lot of good work done between 2009 and 2011 that were completely forgotten once the heat went out of the issue at the end of the boom.  If we wait until the heat rises to a sufficient level before we start to analyse the problem, we will likely just repeat history by getting overtaken by another change in the cycle.

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