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Principal risks
Risk is an inevitable facet of business. Lonmin faces many risks to the delivery of its intended business outcomes. Lonmin has a formal process that identifies and reviews risks and devises mitigation plans to address the known risks with progress against these action plans being reviewed regularly. The Company's strategy takes into account these known risks, but risks will exist of which we are currently unaware. As required by law, there is a discussion below of the principal risks and uncertainties faced by the Group based on our current understanding but readers should be aware that this is not an exhaustive list and new risks may emerge or the severity or probability of the occurrence of known risks may change from time to time.
The Board of the Company has adopted its present strategy as it believes it is the one most likely to add the greatest value for shareholders and other stakeholders. The strategy is a product of our current understanding of the balance between supply and demand for Platinum Group Metals (PGMs), the implications of this for the pricing of the individual metals in the future, and the risk of successfully executing the strategy. It is possible that, with time, factors become known that indicate that the strategy currently being pursued is not the most efficacious and that alternative strategies may have been more appropriate.
The Group has set stretching targets for the organic growth of its operations and for its growth generally. This will necessitate considerable capital investment, both to secure the resources and to build out mines and associated metallurgical processing capacity. The Group's existing operations will require continued capital expenditure both to maintain and expand above the current level of production. While the Group enjoys excellent relationships with its lenders and is currently able to support the level of debt it plans to carry, there is a risk that this changes in the future. In addition, the opportunity to acquire new resources that will provide the increased levels of production targeted by the Company may not arise or may be priced at such a level that the Company decides not to pursue these. There is inherent uncertainty in any forecast and, therefore, there will be uncertainty that forecast operational performance will be achieved. This may be due to changes in project execution risk that could result in high costs and delays. The Group is also leading the industry in terms of its commitment to mechanisation and automation. While well understood in the mining industry globally, the PGM sector in South Africa has not tended to adopt such strategies and there is inevitably risk associated with pioneering any new operational methodology. Finally, all of the expansion envisaged by the Group will require additional skilled people, at all levels of the organisation. In view of the global commodities boom, there is a significant shortage of skills in our industry and severe competition to secure the best people. There is, therefore, a risk that the Group may not be able to attract and retain the skilled people it needs to execute its strategy.
In order to access the ore body, shafts need to be sunk and all of the underground infrastructure built ahead of time. This work is generically referred to as 'development' and requires considerable capital investment to access ore reserves, the quality of which is based on geological estimates. There is therefore risk associated with the variability in any ore body such as the Bushveld Igneous Complex and while we have significant experience of our ore body and have the benefit of a relatively constant ore body thickness and grade, there is no absolute assurance that we will not encounter variability in future. These risks also apply when the Group acquires resources. The Group's reserve estimates take into account actual exploration and production results, depletion, new information on geology and fluctuations in production, operating and other costs and economic parameters such as Platinum price. As a control, the Group undertakes an annual audit of ore reserves by a competent person working to globally accepted standards, with independent confirmation occurring in every alternate year. These factors could result in reductions in its ore reserve and resource estimates which could impact on our life of mine plans and consequently on the net present value of the Group.
While all mining companies are exposed to the risk of disruption to production (see the description on mining sector risks), there may well be risk factors specific to Lonmin that cause such interruptions to occur. The Group suffered an explosion at its main smelter in December 2006 and it has suffered from previous incidences at this facility. The Group believes it has improved its method of operation of this critical plant and has invested in significant alternative smelting capacity to minimise the impact of any incident, however the risk of further incidents cannot be ruled out. The smelter and associated base and precious metal refineries are critical to the Group's processing capabilities with any material interruption to production at these sites having a material impact on the overall performance of the Group. While intermediate products could be sold externally to mitigate the impact of any such interruptions, this is likely to be at a lower margin than would be achieved were the materials fully processed in the Group's own operations. With any production system, risks will always exist that inefficiencies in the processes mean that we do not recover the maximum amount of PGMs from the ore that we mine. As the mining capacity of Lonmin increases, Lonmin may have to increase its processing capacity. However, there is a risk that we do not phase the increase in capacity of these two areas appropriately which could fail to optimise performance.
There is a risk that the Group will not be able to implement its chosen strategy either successfully or quickly enough and as a consequence will suffer cost inflation in absolute terms and consequent margin erosion, leading to a reduction in its net present value. There is also a risk that Lonmin responds less well to industry-wide cost pressures (which are discussed in the section on mining sector risks) than its competitors. Such relative cost increases could result from Lonmin-specific factors (such as a deterioration in industrial relations, failure to implement mechanisation and automation successfully, poor purchasing negotiating skills) or from our competitors being able to address such cost pressures faster or more effectively.
Demand for Platinum, Palladium and Rhodium is primarily driven by the autocatalysis sector, with the main factors being the emissions standards imposed by legislation and the global trend towards diesel-engined vehicles (which predominantly use Platinum as their catalyst). There is also some effect on demand from the engine size of the vehicles being manufactured and there will be changes in demand for each of the individual metals as the weightings used for catalysis alter with technological innovations. The platinum jewellery sector tends to be price-sensitive although, within this, the bridal jewellery market shows less sensitivity to price. In recent years, the price-led reduction in demand for platinum jewellery has led to the emergence of a market for palladium jewellery, modestly increasing demand for that metal. The remainder of the demand for PGMs comes from a variety of industrial applications, many of which are relatively new and for which the demand sensitivity to price through the full commodity cycle has yet to be fully experienced and understood. Although the overall demand for PGMs generally is forecast to remain strong, there is a risk as autocat manufacturers thrift and substitute. There is also a risk of a technological breakthrough enabling the wholesale replacement of PGMs as the primary material for autocatalysis. Within the jewellery sector, there is the risk of a reduction in demand for PGMs in general, and platinum in particular, due to increased substitution by other precious metals.
clearly an oversupply of PGMs would have the same economic impact on commodity pricing as a reduction in the level of market demand. The vast majority of the world's PGM resources are in South Africa (which currently hosts over 75% of total worldwide platinum production) although there are significant commercial PGM ore bodies in Zimbabwe, Russia, Canada and the USA. At the macro-economic level, the relative levels of country risk associated with each jurisdiction may have an impact on the quantities of PGMs produced in each year, with the risk that there may be fluctuations in the level of supply caused by local economic and regulatory conditions. The decisions made by each of the major PGM producers will also have an effect on the overall level of market supply and, although each of the industry majors has an aggressive growth profile and a number of smaller competitors have ambitious plans, there must be significant uncertainty as to whether or not all of the projects currently planned by the PGM industry will ultimately be developed to full production. There remains a degree of risk that a major new ore body will be discovered that would fundamentally alter the balance between supply and demand and, therefore, the long-term price of PGMs in general and platinum in particular.
The market price for PGMs can fluctuate widely, both from the impact of the normal supply and demand factors but also as a consequence of speculation in the individual metals. Therefore, there is a risk that the price of any given metal may fall and that speculation may accentuate this trend. The price of PGMs may also be affected by various other uncertain market factors such as financial market expectations regarding interest and inflation rates and movements in the relative worth of currencies.
The market price for PGMs can fluctuate widely, both from the impact of the normal supply and demand factors but also as a consequence of speculation in the individual metals. Therefore, there is a risk that the price of any given metal may fall and that speculation may accentuate this trend. The price of PGMs may also be affected by various other uncertain market factors such as financial market expectations regarding interest and inflation rates and movements in the relative worth of currencies.
Labour, steel, fuel, power, consumables, chemical reagents, explosives and tyres form a relatively large part of the operating costs of any mining company. The Group is not immune to these cost pressures and significant increases in any or all of these would have a profound impact on total operating costs and, in the absence of mitigating economic fluctuations, result in significant increases in total expenditure, reduction of profit margins and thereby reduce the net present value of the Company. These cost pressures are exacerbated by two additional trends. Firstly, most underground mines are now generally facing the challenge of extracting minerals from greater depths, which requires higher levels of support (and therefore greater use of steel and other materials) and greater ventilation and air cooling, which requires additional power. Industry-wide, costs are therefore rising more quickly than would otherwise be the case. Secondly, most mining companies are looking to expand production during the current global commodities boom which has significantly increased demand for all of these key inputs and led to price rises.
The Group's labour costs are incurred primarily in South Africa and, although cost inflation in that country is now well controlled, almost all employees are members of recognised trades unions and there is a risk that wages may increase by more than the rate of inflation. As a consequence, the Group must strike the right balance between risking interruptions to production and the additional costs that would be incurred in meeting the wage demands made by our employees' trade unions. There is also a long term decline in employee productivity faced by the entire industry which further exacerbates the cost trend. The Group's response has been to develop a strategy for the mechanisation and automation of its mines but labour costs will remain a material expense for the Group for the foreseeable future.
The cost of executing planned capital projects is affected by all of these factors and is additionally exposed to the risks of delay in bringing the new capacity into production. Currently high levels of demand mean that certain types of equipment are difficult to source without significant delay, and there is a significant risk of cost over-runs on capital projects caused by both the underlying cost pressures and the delay in installing critical plant. There is, therefore, a risk that capital projects are not pursued as planned, are deferred to a later time or, if implemented, fail to deliver the expected financial benefits or to deliver production on time.
Mining is susceptible to numerous events that may have an adverse impact on the performance of the Group, either by causing severe damage to capital assets, or by necessitating the suspension or even termination of operations. These events include, but are not limited to, the availability of critical inputs (including power and water), environmental hazards, industrial accidents, underground fires, labour disputes, encountering unexpected geological formations, unanticipated ground and water conditions, accidents in underground operations, failure of mining pit slopes and tailings dam walls, legal and regulatory restrictions and changes to such restrictions, seismic activity; and other natural phenomena, such as floods or inclement weather conditions.
As noted above, mining operations in South Africa are highly unionised and, in Lonmin's case, a single union represents the vast majority of the Group's workers. There is, therefore, a risk that strikes or other types of conflict with unions or employees may occur which, if material, could have an adverse effect on the Group's performance and its financial condition. HIV/AIDS remains the major healthcare challenge faced by the Group's operations, with a 2003 epidemiological survey (one of the largest ever undertaken in South Africa) suggesting that 26% of our employees are HIV positive. In response, the Group has initiated a programme of anti-retroviral drugs for those whom it might benefit, backed up by appropriate encouragement to undertake an HIV test through a voluntary counselling and testing programme. While the results of this have been very encouraging, with the vast majority of those who may benefit now on ART and generally back at work, HIV/AIDS will pose an ongoing and conceivably increasing risk for the foreseeable future. The other principal challenges facing the Group are tuberculosis and other occupational lung diseases, particularly among those who have previously worked in South Africa's gold mines, whilst there always remains a risk that another health pandemic could affect our workforce.
Lonmin is committed to Zero Harm to our employees, to the environment and to the communities in which we operate. This is one of Lonmin's key values in which we invest significant time, effort and money. However, whatever effort we put into these areas, there is a risk of injury, environmental discharge or negative impact on the community arising from our operations. Lonmin actively manages these risks by monitoring trends and engaging others in our goals but there is a risk that isolated incidents could lead to adverse consequences including production disruption.
because of historical factors, the ownership of land in South Africa can be subject to challenge from those alleging that they were wrongfully dispossessed of the land. In common with the rest of the industry, the Group faces a number of such claims. Successful land claims on property falling within the Group's mining licence areas could increase the Group's cost base as compensation would be payable to land owners for any loss or damage suffered by them as a result of prospecting or mining operations conducted by the Group on their property.
The Group operates in five countries and has joint venture interests in one other. In each jurisdiction, the legal and regulatory regimes will continue to evolve in response to external events and the Group must address the obligations and responsibilities that this creates. While the Group does and would lobby for change where appropriate, any such changes are ultimately driven by the governments of those countries and are outside the Group's control. There is, therefore, a risk that change may be introduced which materially disadvantages the Group and with which it must comply.
The Group also faces the risk of fluctuations in profitability caused by movements in foreign exchange rates and is particularly sensitive to movements in US Dollar/South African Rand currency pair. Most of the Group's operations are in South Africa and so incur costs in Rand while the revenue stream is almost wholly denominated in US Dollars. Further information about how the Group manages foreign exchange risk is included in the Financial Review. The Financial Review also provides details of other financial risks including interest rate risk, liquidity risk and commodity price risk.
Mining companies globally are subject to a variety of local industry-specific laws and regulations. If these laws and regulations were to change and material additional expenditure were required to comply with such new laws and regulations, it could adversely affect the Group's performance and its financial condition.
demand for the Group's products is a factor of world economic conditions – for example, during a consumer boom, more automobiles will be sold, creating greater demand for PGMs. However, during a world economic slowdown or recession, it is possible that demand for all products, including those containing, or made in processes requiring the use of, PGMs would reduce and commodity prices generally would fall. As a consequence, the Group's prosperity is intricately linked to general economic conditions and there is a risk of material deterioration in the Group's performance and finances during such macro-economic events.
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Lonmin at a glance
- Our operations, consisting of eleven shafts and inclines, are situated in the Bushveld Complex in South Africa, a country which hosts nearly 80% of global PGM resources. We have been granted a New Order Mining Licence by the South African government for our core operations, which runs to 2037 and is renewable to 2067. We have resources of 175 million troy ounces of PGMs and 43 million ounces of reserves
- No. of full time employees around 27,800 (yr ending 30 September 2011)
- Primary listing on LSE, also on JSE
- 719,000 ounces of Platinum in concentrate (1.436m ounces of total PGMs) produced and 721,000 ounces of Platinum sold (yr ending 30 September 2011)
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