When Higher Metals Prices Aren't Good for Miners

A couple of interesting data points on costs in the mining industry.

Cost containment is once again becoming a major issue for miners. TD Newcrest analyst Greg Barnes told a Canadian Institute of Mining, Metallurgy and Petroleum conference in Vancouver this week that inflation of operating and capital costs has become "endemic" across the business.

Barnes noted that the average capital intensity for new copper mines has doubled over the last ten years, from $4,000 to $5,000 per installed tonne of capacity to currently over $10,000 per tonne. Costs may range up to $15,000 per tonne in difficult environments.

He believes the situation in similar in nickel, where capital intensity has "gone through the roof". TD's analysis shows that nickel developers are paying $35 to install a pound of production capacity.

Costs are the "silent killer" in the mining industry. Too often, investors simply look at metals prices as a gauge of profitability in the sector. But even at high metals prices (such as we have today), profits can be slim if costs for steel, fuel and labor rise in step.

This is a problem with inflationary environments. Rising prices can make it appear that miners are making money hand over fist, when in fact profit margins are holding steady or even contracting.

As if to reinforce this point, China announced yesterday that its aluminum producers will be facing significantly higher costs going forward.

The National Development and Reform Commission said in a statement that the government has stopped selling discounted power to aluminum producers, effective immediately.

Power can make up 40% of the cost of aluminum production. Up until now, China's aluminum-makers have had such costs contained through buying subsidized government power. But these companies will now have to bear the full brunt of power costs. Driving up overall production costs significantly.

Bottom line: when looking at producing miners, be sure to check both sides of the profit equation.

By. Dave Forest of Notela Resources