Rises in commodity prices could set Mexico's mining industry on new path

The country has long been a global presence in the mining industry, but since 2012 falling commodity prices, coupled with increased royalty payments, have led to stagnation of both production and investment. In early 2017, however, the recovery of metals prices saw a rise in merger and acquisitions in the global mining industry, and a growing belief that a new bull market could be on the horizon. With huge exploration potential, Mexican mining could soon be back after a hiatus.

Silver & Gold

Mexico is the world’s leading producer of silver, with the states of Zacatecas, Durango and Chihuahua serving as production centres for centuries. In 2015 annual production grew by 4.9% to nearly 175m oz, and preliminary results for 2016 indicate a total production of around 164m oz. Fresnillo, a Mexican firm incorporated in the UK, is the world’s leading silver miner, producing 50.4m oz over the course of 2016, up 7.1% on 2015. The firm expects to increase its 2017 output to between 58m and 61m oz. Canadian miners Pan American Silver and First Majestic Silver also own major mines in Mexico. According to preliminary figures from Pan American Silver, the firm’s 2016 silver production reached 25.4m oz, and 2017 production is forecast to remain in the range of 24.5m to 26m oz. Meanwhile, in 2016 First Majestic Silver produced 18.7m oz of silver, with expected output of 11.1m-12.4m oz for 2017.

Mexico is also one of the world’s top-10 gold producers, with 4.4m oz of the yellow metal mined in 2015, a 25.7% increase over the previous year. Gold production is spread among a number of Canadian firms, including Alamos Gold, Argonaut Gold and Timmins Gold. The northern states of Sonora and Zacatecas are the heartlands of the industry, producing 31.6% and 27.6% of output, respectively, although the southern state of Guerrero is considered to have major future exploration potential, producing 6.7% of Mexico’s gold in 2015.

Copper

Mexico is also a major producer of base metals and other minerals. It was the world’s 10th-largest copper mining country in 2015, producing over 485,000 tonnes, up 7.3% year-on-year, with more than three-quarters of national production originating from two mines in Sonora run by local firm Grupo México. In addition, the country is an important producer of zinc and tin, principally as by-products of Canadian firm Goldcorp’s Peñasquito polymetallic mine in Sonora. The mine is also Mexico’s single biggest gold mine.

Commodity Cycle

The country’s mining industry has faced a combination of challenges in the past few years. Along with its Latin American peers, Mexico has borne the brunt of falling metal and mineral prices as the global commodity supercycle came to an end. While the value of commodity exports across the region more than doubled between 2004 and 2011, changing price dynamics and weaker demand have shifted momentum. Estimates suggest commodity export revenues in Latin America fell from a peak of $550bn in 2011 to $480bn in 2014 – a drop equivalent to 1.5% of the region’s GDP, according to UK-based Capital Economics.

Some economies were hit harder than others, such as Brazil, where the drop in prices exposed significant structural imbalances. For its part, Mexico appears to be better positioned than most, thanks in large part to diversification strategies. Projections from the Centre for International Development, a research group at Harvard University, suggest Mexico’s economic growth could outpace that of Brazil and the rest of Latin America over the medium term.

Hard Time

In addition to the fall in commodity prices that began in late 2012, Mexican miners have also had to contend with tougher fiscal conditions. In 2014 the Mexican government introduced a 7.5% royalty fee on all metals, with an additional 0.5% levy on precious metals. The move went way beyond the anticipated 3-4% royalty and, given that the price of gold fell from an average of around $2000 per oz in the second half of 2012 to under around $1060 per oz by the end of 2015, the new tax hurt miners already operating at much thinner margins. “From 2004 until the end of 2011, Mexico emerged as a competitive destination for mining investment, and the country was frequently a focus of the highest exploration expenditure in Latin America,” Sergio Almazán Esqueda, director-general of the Mining Chamber of Mexico (Cámara Minera de Mexico, Camimex), told OBG. “However, since then the panorama has changed, and we have seen a reduction and then stabilisation of investment.”

Exploration activity was also hindered by new laws. “The system in Mexico for generating new titles has slowed considerably, which has created challenges for the exploration sector,” Joness Lang, vice-president of corporate development at Riverside Resources, which has exploration projects in Mexico, told OBG. “A couple of years ago the Mexican government introduced a new stage to the process whereby Petróleos Mexicanos must sign off on there being no hydrocarbons potential before ground is released and/or updated titles are issued. This has created problems for many, especially foreign investment that does not have the experience and on-the-ground knowledge to manage and expedite the process,” he added.

Tighter Belts

According to preliminary data from Camimex, investment in the Mexican mining industry in 2016 was approximately $4.7bn, with a slight rise expected in 2017. This is down from 2012, when the industry received $8.3bn in investment. “Prices and regulations have forced companies to reassess their expenditures in Mexico,” Almazán told OBG. “Some projects have been put on hold, and exploration budgets have been the hardest hit.” As well as expansion plans to some existing mines, Mexico has several major projects in the development stage. The Juanicipio mine in Zacatecas, a joint venture between Fresnillo (56%) and MAG Silver (44%), is a $305m investment set to come on-line in 2018 with annual production of 30,000 oz of gold and 10m oz of silver. In the same year, a $324m copper and silver project known as Rey de Plata is set to start production in Guerrero state, after being delayed in 2017 due to lower commodity prices. However, some projects have been put on hold, such as Chesapeake Gold Corporation’s $4.36bn Metates gold project in Durango. With proven and probable reserves of 18.5m oz of gold, 526m oz of silver and 1.9bn kg of zinc, according to Tucson-based Independent Mining Consultants, operations at Metates were postponed to 2018, but by early 2017 there was no indication of plans to move forward. Other firms have divested away from non-core assets. In January 2017 Goldcorp sold its Los Filos gold mine to Leagold Mining Corporation for $438m. The previous year Goldcorp cut the mine’s gold reserves by 78%, or 5.3m oz, on the basis that lower gold prices made the project unprofitable. Goldcorp is also expected to sell its Camino Rojo gold and silver project in Mexico, and in December 2016 the firm hired the Bank of Nova Scotia to evaluate a possible sale.

Consolidation Before Expansion

Leaner years in Mexico’s mining industry have fuelled a flurry of mergers and acquisitions among international companies active in the country, which could put firms in a better financial position to pursue exploration. Canada’s Alamos Gold and AuRico Gold merged in April 2015, creating a company with a market capitalisation of around $1.5bn, while Vancouver-based Timmins Gold acquired Newstrike Capital in May of the same year. Later that year, in August 2015, First Majestic Silver bought out Silvercrest Mines for an estimated $118m, while Southern Copper Corporation, a subsidiary of Grupo México, purchased the El Pilar copper mine from Canada’s Stingray Copper for $100m. El Pilar could start producing 35,000 tonnes per year in 2018 thanks to $300m in capital expenditure, suggesting that industry players are still betting on future demand.

New Projects

Nowhere has the decline in mining market sentiment been more keenly felt than in the exploration sector, however. According to Camimex data, in December 2015 a total of 154 projects, mainly at the exploration stage, were on hold across the country. Furthermore, greenfield exploration budgets fell from a high of $1.17bn in 2012 to $483m in 2016. However, few junior mining firms have pulled out of Mexico, preferring instead to enter a “care and maintenance” mode during the downturn. According to figures from the Ministry of Economy, there are 267 foreign mining companies in Mexico with over 900 projects.

Around two-thirds of the junior mining firms operating in the country originate in Canada, and in February 2017 the two countries signed a memorandum of understanding (MoU) focused on improving geoscience, clean innovation and corporate social responsibility in the mining sector. Despite the country’s long history of mining, there is still significant potential remaining for the discovery of major deposits of precious and base metals. “Only 27% of Mexican territory has been explored, and many of the country’s mines rank globally,” Mario Alfonso Cantú, the deputy mining of minister, said at the annual Mexico Mining Forum in February 2017, held in Mexico City.

Greenfield exploration projects are under study across the country, both in traditional mining zones and in new frontier regions, such as the Guerrero Gold Belt in the south of the country and the previously non-mining state of Puebla. “Mexico’s rich mining history provides great guidance for current exploration,” Lang told OBG. “Many historic, well-known districts have been mined to shallow depths, or were the site of small-scale, high-grade artisanal mining. This historic work can often lead junior explorers beyond the past low-hanging fruit to the discovery of much larger-scale deposits that can support large open-pit mining.”

Security

While Mexico is one of the most mining-friendly countries in the world – the constitution gives preference to mineral resource exploration and exploitation over any other use for land – one of the most troubling issues for the sector in the country is security. Not only does it only deter investment, but it results in significant costs for operators in certain regions. However, many feel there is already official recognition of the need to address this. Jesús Herrera Ortega, CEO of mining firm Detector Exploraciones, told OBG, “One of the government’s main priorities is to improve security levels. A number of states are still considered unsafe to operate in. Security issues in these areas could be eliminated by increasing local investment in security, and boosting regional economies to improve well-being and economic opportunities,” he added. Chris Warwick, Pan American Silver’s country manager for Mexico, told OBG, “Although robberies are an issue, they are often carefully coordinated inside jobs. In any case, security spending by the private and public sectors has gone through the roof, with fewer major incidents as a result. Even though there are fewer incidents, they do continue to happen.”

The perception is sometimes more important than the reality, and a 2016 Camimex study concluded that in just one year, the Mexican mining sector had lost out on $48m worth of investment due to security-related issues, and that investment in private security in the sector had increased by 5.1%. This is something that needs to be addressed if investors are to be enticed away from other Latin American producers such as Chile, Argentina and Peru.

Reform Push

In the first half of 2016 and again in early 2017 a rapid rise in gold prices suggested that a new bull market for mining companies could be beginning. However, if Mexico is to fulfil its potential, certain changes will be required, according to Almazán. “In recent years we have seen other Latin American countries make serious efforts to make mining more attractive and to promote their countries at international mining events,” he told OBG. “The Mexican government should promote exploration and provide a more stable long-term legal environment for the sector.” Over the course of 2017, Camimex will propose three changes to how the sector is run. First, it is planning to offer a revised plan that does away with the 7.5% royalty fee in order to bring the country more in line with competitors like Peru and Australia. Second, a new proposal will allow exploration firms to deduct expenditure from their tax bill in the same tax year, rather than the following year, providing more breathing space to junior companies with limited budgets. Third, Camimex is pushing for changes that will ensure funds spent on community relations and environmental projects are tax deductible. “We want Mexico to regain competitiveness, and these three points are the focus of our efforts,” Almazán told OBG. “We are seeing positive signs that the government is beginning to prioritise the sector, such as the December 2016 creation of the position of deputy minister of mining at the Ministry of Economy. Our long-term goal is to make Mexico one of the five leading mining countries in the world.”

Outlook

With the prospects of higher prices over the course of the next two years, the sector can expect to see renewed exploration, project development, and merger and acquisitions activity. “We see exploration budgets increasing for many major and mid-tier producers in 2017 and 2018, and believe the result will be more joint ventures and partnerships with the project generators that have quality inventory,” Lang told OBG. However, mining is even more dependent on political support than other industries, and a concerted effort to improve the industry’s image and reform legislation will be crucial to attracting greater interest in the country.