Peru mining steady despite volatile prices

By any measure, Peru is a giant of the global mining industry. Only Chile and China produce more copper and the country is the world’s seventh-largest producer of gold and the third largest of silver. Add to that important deposits of zinc, tin, lead and iron ore, as well as non-metallic resources such as phosphates and uranium, and it is unsurprising that Peru’s economic fortunes have been tied to the mineralogy of the Andes mountains for many centuries. Since the liberalisation of the industry in the 1990s, local and foreign investment – increasingly Chinese – has been deployed to develop major modern mines.

Funding Cycle

The pace of investment gathered speed since 2010, when the commodities cycle pushed up prices of the country’s key mineral exports. Of the $34.4bn invested in Peruvian mining projects since  1996, 60% was deployed between 2011 and 2015, according to Guillermo Shinno, deputy minister of mines and energy. The mining industry has been the driver behind the growth of the Peruvian economy for 10 years, today accounting for about 17.6% of GDP and half of exports. While in 2014 the sector only employed about 195,000 people directly, the number of indirect jobs relying on mining was over 1.7m.

The last three years of falling copper and gold prices – the industry’s primary exports – is a cause for concern. The slowdown of the Chinese economy has led to lower demand for copper and mining operators around the world are readjusting their calculations to assess whether developing their projects is  still feasible under the current conditions. However, the slowdown in the commodity cycle has coincided with the cooling off of Peru’s own mining investment cycle.

“As a result of the current low-price environment, new exploration projects are not being carried out,” Victor Gobitz, general manager at Milpo, a Peruvian mining company, told OBG. “That being said, output is growing in operating mines, which is why Peru is expected to become the world’s second-largest copper producer in the next few years.” Despite the lack of new exploration, a number of major new fully financed projects are now either producing or close to it, meaning the sector is about to get bigger. With existing mines working to  reduce  costs, Peru looks well placed to ride out a period of low prices.

Copper

Between 2008 and 2014 Peru’s copper production was relatively stable, fluctuating between 1.24m tonnes and 1.38m tonnes. However, 2015 saw a new generation of projects enter commercial production, giving a boost to figures for the first half of the year. According to preliminary information published by the Ministry of Energy and Mines, the country extracted 1.7m tonnes of copper, a 23.46% increase on the same period the previous year.

In April 2015  Hudbay  Minerals’  Constancia  porphyry project in the department of Cusco began production. The $1.7bn investment will add 82,000 tonnes of copper to Peru’s output. Following delays relating to  metallurgical  issues,  Chinalco’s  $3.5bn  Toromocho project ramped up to full capacity in June 2015 and is expected to produce 184,000 tonnes by 2016. The project has an estimated resource of over 7.3m tonnes and a mine life of 32 years.

UP & COMING: Two further projects are close to coming  on-line. The expansion of Freeport-McMoRan’s Cerro Verde project is due to be completed in the first half of 2016, boosting its production from 230,000 tonnes per annum (tpa) to 500,000 tpa. Around the same time MMG’s Las Bambas mine is set to enter commercial production, ramping up to full 400,000-tpa capacity in January 2016. Meanwhile, major copper producers with existing projects – Compañía Minera Antamina, Southern Peru Copper and Compañía Minera Antapaccay – also posted modest production increases in the first half of 2015. “Even though there are almost no new projects being developed, mining companies are investing heavily to increase the capacity of operating mines and improve efficiency in each part of their processes. Suppliers also have to adapt to the new times.” Javier Canala-Echevarría, general manager for Peru & Chile at Clariant, told OBG. Peru’s total copper production is set to hit 2.5m tpa in 2018, nearly double its 2014 figure and elevating the country above China to become the second-largest producer after Chile.

Precious Metals

In contrast, Peru’s gold production has been in steady decline over the past decade. “Even though the price of gold has historically been counter-cyclical, the current economic downturn hasn’t resulted in an increase in gold prices.” Victor Anyosa, general manager at EPCM experts, told OBG. “This is because trust in the financial systems is high and governments and central banks have been selling off their gold assets,” he added.

In 2015 just under 4.7m oz were extracted, compared to 6.7m in 2005. The key reason for the decline is ramping-down of the country’s two biggest gold mines  Yanacocha  and  Misquichilca. Back in 2005  Yanacocha, in Cajamarca,  produced 3.1m oz per year, but by 2014 this had dropped to some 970,000 oz. As the country’s primary gold mines go into decline, they are not being replaced by new ones with the same capacity.  Recent projects have been on a far smaller scale. Since 2009 seven new gold mines have entered production with a combined production of 770,000 oz in 2014. Over the same period, production from Yanacocha fell by over 1m oz.

Silver has fared better. In 2015 Peru produced 131m oz, its highest figure since 2009, boosted by associated silver production from the  Toromocho  copper mine and the commencement of  Volcan Compañía Minera’s polymetallic Alpamarca mine. In the first nine months of 2015 output reached 95m oz of silver, a 6% increase year-on-year (y-o-y). In June 2015 Hochschild Mining’s Inmaculada mine entered production with a guidance of 73,000 oz of gold and 2.1m oz of silver before the end of 2015.

Prices

Until 2012, however, Peru’s declining gold production was masked by booming export figures. Backed by rising prices, gold exports – principally to Switzerland, Canada and the US – more than trebled from $3bn in 2005 to $10.2bn in 2011. However, to a large extent gold’s bull run, which led to peak prices of over $1900 per oz in 2013 was driven by fears over the inflationary effect of quantitative  easing. When these concerns subsided and investors pulled out of gold as a hedge play, the price plummeted, stabilising at approximately $1068 per oz by December 2015. Gold exports continued to fall in 2015, and were down to $596m for the year, having declined from $674m in 2014.

Having peaked at over $10,000 per tonne in February 2011, copper prices have been in steady decline since the end of 2013 in tandem with other metals. In August 2015 copper prices dropped below $5000 per tonne for the first time since the financial crisis. The lower prices has had an impact on Peru’s macroeconomic growth. The GDP of the sector fell 2.11% in 2015, while exports from mining dropped to $20.4bn, down from a peak of $27.5bn in 2011.

Cutting Back

When commodity prices are high, miners tend to focus on expanding production and reserves. This can lead to inefficiencies. With cheap energy priced at rates less than half of that in Chile, and with far lower  wage bills,  Peru’s large copper mines are among the lowest-cost producers in the world. However, efficiencies can still be found.  Southern Copper’s operating costs dropped from $1.92 per pound of copper in 2013 to $1.66 in the first quarter of 2015. In August 2015  Freeport-McMoRan, announced that it aimed to cut operating costs for its global copper production to $1.15 per pound. Meanwhile the Toromocho project estimates that it will produce a pound of copper at an operating cost (after credits) of just $0.68.

Even the regulatory bodies are looking for ways to make their operations more efficient. In April 2015, for example, the Supervisory Organisation for Investment in Energy and Mining announced it had begun a pilot project that uses drones to monitor and supervise mining operations in the Rimac valley.

Services providers have also been noticeably affected. “Operating mines continue to produce similar or higher levels of output in this low-price environment,” Julio Molina, general manager at Distribuidora Cummins Perú, an international equipment supplier, told OBG. “This means that their demand for goods and services from suppliers has not stopped and it is not expected to do so.” While work continues apace, efficiencies are affecting margins. Marcus de Monzarz, general manager at Sandvik, an equipment supplier, told OBG, “The current environment of low commodity prices is putting pressure on mining profits. This has created additional pressure on suppliers who are now optimising their cost structure.”

Maintaining The Grade

With their  projects already running at very low costs, managers at Peru’s largest copper mines do not face the  dilemma  of whether to “high-grade” their mines in 2016. “High-grading” refers to the process whereby miners change their operation  plans to focus on extracting the best ores from  their pits during periods of depressed prices. The short-term benefit is that processing costs are kept low and the mine can make money at low prices. However, if commodity prices fail to rise, the mine can be left with a large supply of low-grade ore that is impossible to extract, reducing the mine’s life. “Perhaps we will see some high-grading at some of the older, smaller deposits,” Ricardo Carrión, managing director of  local brokerage firm Kallpa Securities, told OBG. “Still, the major mines are profitable at current prices, although obviously it will lead to a longer payback period for new projects.”

Investment Cycle

The completion of  Las  Bambas, the last of the three copper mega-projects, will signify the end of the current cycle of mine construction. From a peak of $9.7bn in 2013, foreign direct investment in mining projects is estimated to fall to $7.5bn in 2015 and then $5bn in 2016. Nevertheless there are still an estimated $61bn of mining projects waiting to be developed in the country, although many of them are on a smaller scale than recent projects. In its annual statistical review, the Ministry of Energy and Mines (Ministerio de Energía y Minas, MINEM) lists about 24 advanced-stage exploration projects targeting a variety of metals and minerals. In addition, there are around fourteen projects in the developmental stage with approved environmental licences. A few of these continue to make advances. In July 2015 Canadian firm Bear Creek Mining released a feasibility study on its Corani project, a silver-leadzinc mine in the Puno area. Buenaventura, a Peruvian company with strong cashflow, is pushing ahead with its $340m Tambomayo gold project near Arequipa.

Other projects have been put on hold as firms look to prioritise their spending. Hochschild postponed the development of its Crespo gold mine in order to focus on bringing Inmaculada to production. Low prices have prompted Anglo American to reassess its capital expenditures globally. In Peru this means dropping its Michiquillay copper project and looking for joint venture partners on its Quellaveco copper project, which has an estimated cost of around $3bn. However, the biggest cause of project delays and cancellations is not metal prices but opposition to mining projects from local communities. An estimated $21bn of investment is stalled due to social conflicts.

Public Resistance

Peru has a long history of major metals projects and in its central mining districts the industry is widely recognised as a driver of growth and a job provider. However, the situation is far from homogeneous across the country and some regions and indigenous groups have been staunchly opposed to mining. The Minas Conga project, a $4.8bn copper project in the Cajamarca department owned by US’s Newmont and Buenaventura, has been one of the most high-profile cases of local resistance. Since receiving its environmental licence in 2010 the project has at times been paralysed by protesters concerned about its impact on water resources.

Conga is not an isolated case. In 2015 the government twice declared a state of emergency in response to violent mining protests. The measure – which suspends the right of free assembly and gives police extended powers to search homes – was introduced first in May over Southern Copper’s Tia Maria project and in September after protests at the Las Bambas expansion project. With elections in June 2016, Peru’s new president will be faced with the task of resolving what seem like intractable problems. The situation could be further complicated in 2016 by an international court ruling on the Santa Ana silver mine in the Puno region. In 2011 the government revoked Canadian firm Bear Creek Mining’s right to construct the mine following protests. In May 2013 the Lima Constitutional Court ruled that the company’s constitutional rights were violated, but the firm was still not permitted to resume operations. The case was referred to the International Centre for Settlement of Investment Disputes, part of the World Bank Group, and a ruling is expected in 2016 or 2017. “Environmental certifications are in high demand from mining and energy companies, as they need to abide by the highly demanding environmental standards set by the government,” Luis Elias, general manager at SGS, told OBG.

Social Licence

The effect of these cases has been to increase investor uncertainty. It remains unclear who retains ultimate power to accept or reject mining projects – the government, the communities, or, in Santa Ana’s case, the international courts. It also pushes up costs. “Increased social protests and new regulations are making more demands on miners,” Angel Murillo, sub-manager for mining at the National Society for Mining, Petroleum and Energy told OBG. “Today firms need to hire teams of consultants to address environmental and social commitments.”

Miners are taking different approaches to win over communities and ensure they maintain their “social licence” for the duration of the project. “The best way to deal with conflicts around mining projects is a combined policy of law enforcement and additional information to the communities that are affected,” Harald Streitberg, general manager at Bosch Perú, told OBG. “This helps to increase transparency and communication among all parties involved.”

Following citizens’ concerns about the effect the expansion of the Cerro Verde copper mine would have on water in Arequipa, Freeport-McMoRan built a $99m water treatment plant to provide drinking water to 750,000 residents. The mine is fed from the wastewater once it has passed through the city. Such projects are beyond the capacity of smaller companies, but even juniors have changed the way they operate to win community support.

At present, royalty rates for metals production range from 1% to 12% of operating profits and are collected centrally. A structural change in the way proceeds from mining are spent could be an option in the future. During a previous administration, miners paid a voluntary contribution, or aporte voluntario, in which 3% of profits – deducted from royalty payments – was set aside for education, health or infrastructure projects agreed upon with local mayors and governors. Many in the mining industry believe that this policy was successful at identifying and undertaking projects based on local needs and building trust between the company and community.

Potential Projects

If a successful model for partnerships between companies and communities is found, the potential for new projects is immense. By the end of 2014 there were over 42,000 mining titles licensed in Peru, with a total coverage of nearly 19m ha – around 15% of the country’s surface. However, less than 1% of the country is under exploration.

Peru’s potential in copper and precious metals is well documented. In the 2016 Mineral Commodities Summary estimated it housed reserves of 82bn tonnes of copper, 18bn oz of gold and 87bn oz of silver. Base metals are also important national products. In 2015 Peru produced 1.42m tonnes of zinc, a n 8.6% increase on the previous year. The commissioning of the Volcan mine added to strong production from Milpo, which is owned by Brazilian firm Votorantim, and zinc byproduct from the Antamina mine. Lead, frequently produced alongside zinc, also saw strong growth in 2015. Between January and August 2015, Peru produced 315,784 tonnes of the dense metal, a 15% increase on 2014 figures.

Chinese Investment

While zinc and lead make up a relatively small percentage of the global metals mix, in the past decade China’s demand for iron ore and its desire to secure different sources of supply spurred project development in Peru. In 2014 the Asian powerhouse imported over 930m tonnes of iron ore to fuel its steel industry, a 14% increase on the previous year. In an industry in which logistics are fundamental to success, Peru has an advantage in that its Pacific coast allows shipments to reach China in 40 days, at least a week faster than shipments from Brazil, South America’s principle iron ore exporter. Peru also has attractive iron ore deposits, although only Shougang’s Marcona mine is currently in production. In the first eight months of 2015, Marcona’s production increased 6% to 5.5m tonnes. A proposed expansion project will double capacity to 20m tonnes per year.

Weak ore prices have not dampened interest from Chinese miners, whose strong financial positions permit them to take a long-term view. China has become the largest investor in Peruvian mining projects, accounting for 35% of inflows in 2014. In January 2015 MINEM approved the environmental permit for a second iron ore mine, a $1.5bn investment by China’s Jinzhao Mining, near Arequipa. The project involves building a $340m port to facilitate exports.

Phosphate

Non-metallic mining was one of the few sectors of the economy to experience export growth in the first half of 2015, rising 22% y-o-y to $640m. Peru produces a number of construction materials, such as limestone, marble and clays, but its primary export commodity in this segment is phosphate, which is used in the production of fertilisers. Despite declining from nearly $200 per tonne in late 2011, the price of phosphate rock has stayed around $115 per tonne in 2014 and 2015, well above the average of less than $50 per tonne seen until 2007. With phosphate prices tied to food demand, rather than industrial output, the segment offers an opportunity for more stable future growth.

Outlook

In the first half of 2015 Peru exported just over $9bn of metals, its weakest six-month performance since 2009. However, Peru’s miners are well placed to withstand a period of low prices, and the entrance of major new projects means 2016 should be a bumper year for production. If commodity prices rebound, the sector will receive a major windfall.

However, if sector development is to continue in a healthy fashion, a coherent strategy for resolving social conflicts will be needed. Implementing policies that promote investment, mitigate environmental risks and provide benefits to communities is thus set to figure among the priorities of future governments.