These new risks are a result of the global commodities boom and economic expansion. They are a result of increased activity in the construction sector in major developing markets, including South Africa, the primary source of materials and expertise for undertaking mining projects in the region.
One such risk is the escalation in demand for commodities used in mining projects themselves and increases in prices of those commodities. For example, the recently experienced shortage of tyres for large earthmoving equipment globally was a result of the economic boom in China. The price of steel in South Africa has surged dramatically in the last two years owing to the import pricing parity formula used in South Africa, which makes its steel manufacturers among the most profitable in the world. This impacts the cost of implementing projects in the region and causes problems in managing steel price escalation.
Rapid construction growth in South Africa has also seen cement producers in the country caught short and most won’t have increased capacity in place until 2008. “With projects such as Gautrain, the Sishen iron ore expansion project, the infrastructure for the 2010 World Cup, the Richards Bay Coal Terminal expansion, as well as Eskom and Transnet projects about to kick in, the cement companies have been too late in implementing expansions,” Massey says. “It is understandable because when the cement industry considered its risk profile a few years ago, it was already profitable and this limited the incentive to take a chance on a non guaranteed increase in demand.”
Massey says this new risk, associated with input commodities for mining projects, came about because the construction and mining industries lost control of these commodities. “This is something that should not have happened. For example, over the past few years the rate of increase in the share price of the major cement producer PPC on the Johannesburg Stock Exchange relative to the share prices of the major construction groups that take risks and actually implement projects indicates this type of imbalance.”
Massey believes the boom in South Africa’s construction sector where growth was reported to be about 8% to 9% last year is conservative, as all builders and civil construction companies are working flat out and have no additional capacity. We are told that turnover in this sector will double in the next four years, so growth will have to be greater than this. If one considers that a typical construction project can take between 18 months to two years, it will be the end of 2007 before any of this capacity is released. This means that projects which have not yet secured resources will either have to be delayed or resources sourced from elsewhere.
A factor contributing to this state of affairs has been the rationalisation between and within construction companies in South Africa over the past few years, and this has been at the expense of capacity. As a general rule, it is also correct to say that mining houses have shed their project management capability and this also impacts on the industry’s delivery capability.
As an example of the limitations of available construction capacity, one mining house recently realised that the total available mine development and shaft sinking capacity that exists cannot meet its own projected expansion and development requirements.
“So there is a shortage of commodities used by the mining companies to implement their projects, there is a shortage of project implementation and construction capacity and there is a shortage of skilled people to implement projects.
“In this environment mining groups that wish to develop projects have to identify such risks and how they apply to each specific project, and they probably should not rely on project companies to do this risk analysis as these have a vested interest,” Massey says. “At the very early stage of a project, mining houses should be keeping their options open. However the implementation strategy could well identify the need for the appointment of such a project company but within the ambit of the overall strategy formulated for the mining house’s specific needs.
“Here you need a contract specialist organisation to advise on the most appropriate project implementation strategy, which would commence with an assessment of the organisation’s appetite for risk. Thereafter, carry out a risk analysis for the specific project taking into account the ‘traditional’ risks as well as the ‘new’ risks referred to above. The implementation strategy can then be put into action and contract forms developed using the most appropriate standard form (NEC, Fidic etc.) including the appointment of the EPC, EPCM or design consultant. This would ensure that risks are identified, allocated to the party best able to manage such and controlled and monitored throughout the life of the project.”
Massey realises that in proposing this he is stepping on the toes of the project management companies who see this terrain as their speciality. “But the point is that there is a lack of both care and skill in the formulation of contracts, which we see on a regular basis manifesting itself in the form of poor contract documentation. Traditionally speaking, contract formulation is perceived as a core skill of the project management companies, and they clearly would not admit to such a shortcoming.
“One answer to this problem is for the draft documents to be independently reviewed by an organisation such as ours,” says Massey. “Such a review is not expensive nor does it take long but it would appear that those who undertake projects often tend to be penny wise and pound foolish in this regard and as a result, poor documentation has become the norm rather than the exception.”
One such implementation strategy, which MDA has used on underground brown fields mining projects, which is particularly appropriate in the existing environment of an acute shortage of skilled personnel and resources to undertake projects, is that of partnering. In this arrangement mining companies form long-term relationships with, for example a project management company as opposed to taking the more adversarial approach requiring companies to compete through the traditional tendering process for each separate contract. This is a process well understood by the industry and favoured by some of the major players who perceive tendering as an inefficient and wasteful process. Many of the criteria used to adjudicate competitive bids are poor indicators of an organisation’s ability to satisfactorily carry out a project.
Any implementation strategy has to be formulated with the benefit of an objective assessment of the organisation’s culture. A mining house which traditionally wields a big stick when carrying out its contracts must be realistic about whether it could change sufficiently to work with its project managers and other contractors on a collaborative, non adversarial basis.
Long term relationships have the added benefit of enabling stretch targets to be adopted from one period of the project, or series of contracts, to another. By benchmarking a contractor or project manager’s performance, performance improvement targets can be set that decrease costs on a year on year basis rather than simply adopting the traditional mindset that the project implementation cost will increase at about the rate of inflation.
“The philosophy regarding contract mining versus mining in-house also appears to have changed over the past few years owing, it would appear, to uncontrolled or uncontrollable costs and the consequent threat to the viability of ‘marginal’ mines.”
Massey explains that ten years ago mining companies opted for the contract mining route almost, it seemed, automatically, possibly to avoid the complexities of labour management or because it was not perceived as part of the core business. “This allowed them to ringfence that issue, particularly in opencast mining where previously the trend would have been towards using contractors. Now it is a 50/50 call on owner operated or contractor operated mines.
Massey also says one should beware so called one-stop shops, as certain companies rely on fixed pricing and then sourcing competencies they don’t have, and in a tight market when budgets are not achieved the solution is to engineer down, which is not good for the project and the client ultimately is the loser. “If fixed price contracts were such a brilliant idea, everyone would be doing it.”
He also notes that whilst geotechnical risk is well understood there is often a shortfall in the geotechnical investigation carried out for mining projects, and in this he does not mean the work done on the orebody. “A great deal of attention is often paid to the geotechnical features of the orebody, but the geotechnical work relating to the construction of shafts and other related structures and process plants is done in a perfunctory way, sometimes to a very detrimental effect.”
Shareholders of mining companies have become more sensitive to the costs of mining and processing than in the past and monitor how well these costs are managed. “This is where the mining companies need to look at their own skills and assess what skills need to be brought in to supplement their in house expertise to the ultimate benefit to any proposed construction project,” Massey says.MRA