Has the pendulum swung too far in the emerging resource sector?
The flight of investors from the resource space has been brought on by the industry itself: projects financed and acquired during the boom times for the sake of size without sufficient concern about the quality of the assets, has led to massive write-downs and wealth destruction. Investors have been burned – have lost faith in the resource industry – and the withdrawal of their capital has quite rightly caused the excesses of the boom times to be purged. But the withdrawal of investor capital for too long in the lows of the resource cycle just sets us up for a repeat of wealth destruction in the future. The responsible building of the resource industry is absolutely dependent on investors, big and small, selectively putting their money behind companies that have quality, low-cost projects with competent management that has integrity – and this investment is critical in the troughs of the resource cycle; those investors typically see the real wealth creation that this industry is capable of.
Difficult times in the resource industry force innovation: as commodity prices sink, focus falls squarely on reducing production costs so as to maintain a reasonable profit margin. Unfortunately cost cutting usually starts with people being laid off, but is typically followed by adoption of innovations that may each shave a couple of percentage points off production costs. If production costs can’t be cut deeply or quickly enough, closures ensue as we have recently seen with large companies like Glencore and Freeport idling copper mines. Closures of this magnitude typically occur at the market bottom, with the reduction squeezing the supply-demand balance, triggering an uptick in commodity price.
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If we can find multiple ways of reducing production costs while maintaining safety standards, environmental integrity and retaining the confidence of local communities, our operation stands a reasonable chance of surviving the cyclical lows in the industry. When resource prices rise, the low-production cost operations should run at higher profit margins than before the cost-cutting, and shareholders should receive an acceptable return on their investment.
But there are important differences for emerging producers – and this is where the main risk lies with the pendulum of resource investment swinging too far into negative territory. Deposits that are discovered with the exploration funds raised in the boom times tend to be subject to economic studies in the waning stages of the resource cycle – because of the time needed to drill out the ore bodies and conduct the multidisciplinary test work required for a comprehensive economic study to be completed. As with existing mines, as commodity prices fall, innovation is forced on the emerging projects – technical people most familiar with the deposits and associated processing techniques, find ways of reducing projected production cost. But there comes a time, such as now, that, due to the disinterest of investors and financiers, the industry is losing the technical brains that have the experience that is likely to lead to cost-cutting innovation. These experienced individuals are leaving the resource industry to retirement – just deciding that it’s not worth the pressure of continuing to work in the resource space – while many of the younger professionals are forced into other industries to put bread on the table.
The loss of these tenacious individuals from the resource sector: the ones that have found the deposits and directed them towards being the mines of the future as a result of the quality of the ore bodies; have driven innovation that has gone into finding ways to extract the valuable minerals most profitably while minimizing environmental impact; those who have contributed to winning over communities to be proud of the development that’s coming to their back yards, means that when the resource cycle inevitably starts to rise, and investment funds begin to flow again, the discoveries fall into the hands of a new crop of people who know the projects less well. With rising commodity prices, there’s less pressure to find ways of reducing production costs, and we end up with mines being brought on stream with production costs that are higher than they should be. The mines function fine during the boom times, and shareholders reap some rewards, but because costs may not have been optimized to the extent that they could have been, shareholders actually receive less benefit than they should. We have seen time and time again, that deposits put into production during the boom times are left high and dry when resource prices decline, exposing the operations to massive write-downs and wealth destruction – and shareholders quite rightly walking away from the industry.
In the good times, our industry sets itself up to fail in the bad times – and we burn our shareholders, and then wonder why investors won’t support us when we need it most – at the bottom of the resource cycle. We’re at that point now, at least in the uranium industry in which metal price has quietly risen some 30% from the lowest price reached in a decade in mid-2014. It’s a pity that many of the shareholders who have seen massive wealth destruction in this prolonged resource down-trend, and have been so badly burned, are unlikely to buy stock near the bottom and are therefore most likely to miss out on massive share price appreciation that typically befalls companies with quality projects as we move into the positive part of the resource cycle. Now, more than ever, it is the responsibility of management of companies that have quality deposits to step up, engage with and re-energize existing shareholders that have hung on in the downturn. Company leaders need to be beating the drum about the shareholder returns that should flow from their quality asset – encouraging investor interest and participation so as to stop the pendulum from swinging so far that it sets us up for excesses at the top of the next resource cycle, and the wealth destruction that inevitably follows.
Richard Spencer is president and CEO of U3O8 Corp., (UWE.TO, OTC:UWEFF and SSE:UWE). U3O8 Corp. (www.u3o8corp.com) is a Toronto-based exploration company with a portfolio of ... <Read more about Richard Spencer>