INDUSTRY COST CURVES FOR SA GOLD MINES AND COMPANIES

The South African gold mining sector has for decades since its record production highs of 1970s seen declines in output. The period in question has seen gold production decline from historical highs of 1000 tonnes(t) of gold annually to only 118.2 tonnes in 2019, which translates to an averaged compound annual growth rate (CAGR) of negative 4,3% year on year.  A micro view for the period 2010-2019, reveals accelerated declines in production of negative 5,6% CAGR as seen in figure 1.

Figure 1:Annual gold production between 2010-2019 (GOLDHUB, 2020)

During the period, the country slid down the ranking as the largest producing nation globally to 8th position and behind Ghana as the leading African gold producer as of 2019. Despite the decline in the country’s gold production for decades now, South Africa’s gold reserves and resources are among some of the world’s largest (Mineral council SA, 2020). Although the country has a comparative advantage in terms of mineral endowment, the industry faces many challenges that hinder the translation of comparative advantage to competitive advantage (Neingo & Tholana, 2016).

Challenges facing SA Gold mining industry sector;

The Gold mining sector in the country has been around for well over a century because of the discovery of the Witwatersrand gold basin in the late 19th century. A consequence of the maturity of the industry is that mining at majority of the country’s mines happens at ultra-deep (depths more than 3250m) below surface and extraction is of the relatively low-grade gold ore reserves. Figure 2 shows that eight of the top 10 deepest underground mines in the world are in South Africa, with an average depth of 3.4KM below surface (Jaansen van Vuuren, 2018).

Figure 2:Top 10 deepest underground mines  (Jaansen van Vuuren, 2018)

At these depths, the cost of electricity and ventilation coupled with the cost of rock support necessary to stabilize the working environment are among the major cost drivers. Electricity supplied to the mining industry from 2008 to 2017 as highlighted by figure 3 has risen significantly further increasing operational costs.

Figure 3:Eskom’s electricity increases from 2008-2017 (ThisisGold.co.za, 2018)

The industry faces other inherent technical issues such as low mineralized zones requiring Stoping width (about 1m) and equipment selection that suits the nature of operation. This in turn results in the heavy reliance of operations on labour (Neingo & Tholana, 2016). These is expressed in the sharp rise in total employee earnings from R15.9 billion in 2008 to R25.9 billion in 2019 despite declining employees’ numbers (Mineral Council SA 2, 2020).Harmony in its 2020 annual integrated report indicated that the cost to employees accounted for as much as 54% of total cost incurred by the company.

These factors and others have over time resulted in South African mines serving as the most expensive to operate in the world with all in sustaining costs averaging US$1,035/troy ounce(oz) compared to the global average of US$818/oz as depicted in figure 4 (ThisisGold.co.za, 2018).

Figure 4:Cost curve for gold mines per region (ThisisGold.co.za, 2018)

With mining companies being price takers in the market, it does mean that during low commodity price cycles majority of the country’s operations are most likely to be unstainable cost-wise due to the high operating costs. Thus, it is crucial at any time to analyze how the industry fairs with ever changing gold price as determined by supply and demand in the market  and a popular way of doing so is with industry cost curves.

Industry cost curves

CHR Metals Limited (2005) as cited in Tholana, et al (2013) defined a cost curve as a graphical plot of cumulative production for individual mines along the horizontal axis (or x-axis), ranked according to unit cash cost of production on the vertical axis (or y-axis), as shown in Figure 5;

Figure 5:Typical industry curve (Tholana, et al., 2013)

The industry cost curves facilitate the identification of high and low-cost producing mines or companies thus informing the cost effectiveness of operations by comparing the costs incurred to produce gold against its market price.  This is because a company operating at the lowest cost is therefore the most competitive and can survive profit margin squeezes when commodity prices decline. In addition, it is likely that the highest cost producers will suspend operations first during periods of depressed gold prices and thus presenting the low-cost producers with opportunities to increase market share. The gold mines and companies cost curves for the year 2019 depicted by figure 6 and 7 respectively was constructed using data from their latest annual integrated reports as published on the public domains.

Figure 6:Mines cost curves for 2019.

 

Figure 7:Mining companies cost curves for 2019.

 

The listed companies and their respective South African mines are coloured identically on the respective cost curves. The average gold price for 2019 was used to compare the cost competitiveness of mines and mining companies for the period in question as means of determining the sustainability of operations. To obtain comparable results, the All-in sustaining cost (AISC) incurred by the different mines was used instead of the cash cost due to all the companies reporting the AISC and not all reporting cash costs.

It should be noted that the AISC is expected to be higher than the cash operating cost due to the inclusion of costs not directly contributing to the production of gold such as sustaining costs(exploration), company general and administrative, among others in addition to the cash operating cost as shown in figure 8.

Figure 8: Cost structures of mines (Denver Gold, 2016)

From the cost curves mines such as Target, Joel, Tshepong and Kusasalethu whose AISC is higher than the gold price did not generate any economic value add to Harmony during the period. Majority of Harmony’s assets are ageing deep lying operations which explains the position on the cost curve as a relatively expensive gold producer compared to its counterpart. Surface operations i.e., tailings re-treatment operations (Ergo, FWGR etc.) tend to lie on the lower quartiles of the cost curve because they do not incur any mining costs, hence they tend to be low unit cost operations on a per ounce basis (Tholana, et al., 2013).  The increased gold price of 2020 due to demand for gold as a safe haven asset provided much needed relief for marginal operations and even better profit margin for low-cost producers.

 

Industry outlook

Curbing the cost of electricity which has more than trebled over the past decade should be a priority for mining companies with deep lying operations as they are most vulnerable to gold price declines. Renewable energy projects are an avenue to cushion operations from intermittent power disruptions and offset to some degree spiraling electricity costs. The recent approval of Goldfields’ South deep mines renewable energy project which will satisfy about 20% of electricity needs provides a glimmer of hope for mining companies to curb rising electricity costs (Bloomberg, 2021).

Another avenue to curb rising operational costs for high-cost producers such as Harmony, Sibanye-Stillwater and Goldfields is perhaps the adoption of ‘mergers and acquisition’ strategies. Mergers and acquisitions offer the companies opportunities to create value through the following reasons (SRK Consulting, nd);

It is equally worthwhile noting that value destruction through ‘mergers and acquisitions’ is a possibility too. Thus, the strategy should be undertaken with a focused and balanced valuation methodologies that achieves an adopted value that is supported by affected investors and other stakeholders.