Logic problem - mining firms need to take a longer-term view than some appear to have been
Mining giant Anglo-American has offered a further update on the protracted preparations of its Minas-Rio iron ore project in Brazil, the cost overruns of which we last discussed here. On 29 January, the company said it now hoped iron ore production would start in 2014, some seven years after it bought the mine – although it also admitted it would never make back the money it has invested there.
analysts believe that, adding the infrastructure costs to the initial price of acquiring the mine, Anglo-American has in total already spent some $10bn (£6.3bn) on the project. now the company has announced it will write $4bn off that investment … at the same time as committing another $5bn more to its development over the next two years to reach ‘first production’.
Since you cannot write off money you have not yet spent, Anglo-American will be fervently hoping it does not have to make another such adjustment further down the line. All of which is a classic example of “we’ve gone too far to pull out now” and a strong reflection of the belief that everything will look better once initial production finally starts to produce some positive cash flow.
On this second point, the company is almost certainly right. Initial production is indeed likely to make things look better because, although the projected costs of producing iron ore have increased 50% on its initial expectations, the estimate $30 per tonne costs are still a long way below the a current iron ore price of $150 per tonne. Assuming iron ore prices remain elevated, the mine will be hugely profitable when it does start producing.
Such a mind-set – that what has been spent is all in the past – suggests an interesting change in the way the company sees Minas-Rio. After all, if Anglo-American had known it would end up costing the best part of $15bn, there is no way it would have embarked on the project in the first place.
However, while the company has accepted it is unlikely its expenditure will ever be fully recouped, the implication now is that will not matter further down the line when the mine is up-and-running because new investors will only be focusing on production costs and not the ‘sunk’ – that is, capital – cost of start-up. The problem is, such a take on life could justify investing in almost anything.
Indeed it is how people can reason themselves into serious financial trouble. They confuse ‘capital’ – the money we put to one side to buy a house, for example – with the money we use to supplement our daily living needs because we want to go out to dinner more or have a nicer holiday or whatever. Anglo-American is arguably employing similar ‘logic’, which would make it a striking example of short-term thinking in what really ought to be a long-term industry.
Still, it would be unfair to portray Anglo-American as the only such offender in its sector. Earlier in January, for example, Rio Tinto chief executive Tom Albarese stepped down after the world’s second biggest mining company was forced to write off some $14bn in the wake of two poorly-timed acquisitions. Back at Anglo-American, the departure of chief executive Cynthia Carroll, has been brought forward.
Ill-managed ventures such as these can be hugely value-destructive for shareholders and one can only hope that the pair’s successors and other managers will learn from the mining sector’s past mistakes. After all, recent history offers a fair few to learn from.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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