Could Mining Companies Be Left High And Dry?

by: Investing News

Spiraling costs. Violent protests. Crippling delays. These are just a few of the pitfalls waiting to snare mining companies that don't carefully manage their projects' water use, according to a new report from rating agency Moody's.

The report, Global Mining Industry: Water Scarcity to Raise Capex and Operating Costs, Heighten Operational Risks, comes as more miners venture further afield, often to some of the most parched places on the planet, in search of new deposits. As they do so, an overall decline in ore grades is driving miners to work harder - and use more water - to produce the same amount of product.

The Moody's report states that miners will spend about $12 billion on water infrastructure this year, up 56 percent from 2011 and 275 percent higher than the $3.2 billion they spent in 2009.

"Water scarcity is already changing the mining landscape as environmental legislation becomes more stringent, and operating in some countries increases political risk as mining companies' water supplies can be restricted if the needs of communities increase," said Moody's analyst and report author Andrew Metcalf in a press release. "If, as a result, projects take longer to complete, and become costlier and riskier to execute, we would expect these factors to exert downward pressure on the [credit] ratings of the mining companies."

The so-called "big six" major producers - BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), Anglo American (OTCQX:AAUKF), Vale (NYSE:VALE), Xstrata (OTC:XSRAY) and Glencore International (OTCPK:GLNCY) - have two-thirds of their operations in countries that Moody's rates as having moderate to high water risk. But in general, "smaller, less-diversified (and especially single-mine) high-yield mining companies that operate in higher-risk regions, such as South America, are likely to become increasingly exposed to event-risk challenges," states the report.

The Pascua Lama mine: At the center of the water fight

Barrick Gold (NYSE:ABX), the world's largest gold miner, is one of the latest companies to find itself in the middle of a water controversy. The company's Pascua Lama project straddles the border between Chile and Argentina.

Pascua Lama is about 10 kilometers from the company's operating Veladero mine. The deposit contains a proven and probable 17.9 million ounces of gold, with 676 million ounces of silver contained within the gold reserves, according to Barrick's website. The company expects to produce 800,000 to 850,000 ounces of gold and 35 million ounces of silver a year over the mine's 25-year life. First production is slated for the second half of 2014.

The mine is one of several highly prospective mineral prospects in Argentina, and one of many examples that has spurred interest in gold investing in South America. The country also possesses large reserves of copper, silver, zinc, magnesium, lithium, tungsten and uranium.

As of November 1, 2012, Barrick had spent $3.7 billion on Pascua Lama. In all, it plans to invest between $8 and $8.5 billion to bring the project into production. But if the past is any guide, those costs could rise: the company's budget was just $3 billion in 2009, according to a December 17, 2012, Montreal Gazette article.

Costs are rising because the company is operating in an incredibly hostile environment: the mine is located in the Andes, between 3,800 and 5,200 meters above sea level, where the air is thin and temperatures can drop to -40 degrees Celsius.

"We underestimated the complexity of the engineering involved and the enormous amount of work," Rod Jimenez, Barrick's vice president of corporate affairs in South America, told the Gazette.

Argentine glacier-protection law has been a slippery slope for Pascua Lama

The company's proposed mining method has also attracted opposition. Barrick has said the project will use up to 38 metric tons (MT) of explosives a day to crumble mountaintops, then up to 27 million MT of cyanide and 33 million MT of water daily to remove the gold.

In 2008, Argentina's government passed a law forbidding mining on or near glaciers, the melt from which helps feed rivers that supply water to communities below, including those in Chile's Huasco Valley, where 70,000 residents grow crops, including grapes.

However, Argentina's president, Cristina Fernandez de Kirchner, vetoed the law. It was reintroduced and passed in 2010, but a court ruling granted an injunction to San Juan province, where the mine is located. In July 2012, Argentina's Supreme Court disallowed the injunction.

"We are in the process of evaluating the text of the decision. However, it is important to point out that our activities do not take place on glaciers," Jimenez told Reuters at the time. "We believe we are legally entitled to continue our current activities on the basis of existing approvals."

On January 30, 2013, the San Juan government released a report that found "no current impact, neither already created nor potential" on nearby glaciers from mining, the Buenos Aires Herald reported.

Still, farmers, environmental groups and some local citizens continue to raise concerns about mining in the area; a nearby community recently filed complaints with Chile's environmental authority over worries that recent avalanches may have polluted a water channel near the mine.

"These events have not had any negative impact on the quality of water around the project," Jimenez said in a statement quoted in a February 5 article.

How miners can mitigate water risk

Barrick is not alone in dealing with contentious and costly water issues. Newmont Mining (NYSE:NEM) recently agreed to spend an extra $200 million at its Conga project in Peru to build reservoirs to provide water to local communities. The move was in response to protests that forced the company to suspend work at the site. Newmont is still deciding whether to go ahead with the project.

Moody's sees tensions between miners and locals over water continuing to rise in the future. However, there are ways for companies to manage that risk. Here are three:

Desalination: The report gives a number of examples of mines that are building desalination plants, which remove salt from seawater to provide water for mining operations. One example is CITIC Pacific, which is building a high-capacity desalination plant (51 gigaliters a year) and pipeline at its Sino iron ore mine in Australia. Still, such technology comes at a cost.

"Not only is the desalination process itself highly energy-intensive, often requiring a dedicated, purpose-built power source, but treated water also has to be transported to the mining site often over significant distances," notes the report. "As a result, desalinated water can cost up to 10 times more than using locally sourced freshwater."

Water recycling: The report points to the El Abra copper mine in Chile, owned by Anglo American, Xstrata and a Japanese consortium led by Mitsui & Co., as a good example of water recycling. The partners aim to recycle 76 percent of the water used at the mine site.

"While such improvements generate incremental benefits, they are usually insufficient to meet a project's total water requirements," states the report. "As such, mining companies are increasingly being forced to source, transport, desalinate and finally 'make safe' raw seawater- an expensive process that can make or break the economic viability of a mine."

Location, location, location: Projects in developed countries have clear rules that give miners a better chance of predicting and at least partially dealing with these costs, according to the report. But it also points out that water worries don't seem to be slowing miners' expansion into water-deprived countries.

"For example, although issues relating to water scarcity have severely hampered several mining operations across Peru over the past two years, Peru's Minister for Energy and Mines Jorge Merino recently told reporters that he expects the country to attract $10 billion of mining investment in 2013, and for investment projects worth $53 billion to be carried out over the next 10 years," the report notes.

The bottom line for investors? Water scarcity may not derail a new mine, but it has the potential to significantly delay a project, especially if competition for water puts the mining company into conflict with other downstream water users. Long delays can then lead to spiralling costs and increase a mining company's exposure to risk, which may have a negative effect on its credit rating and share price.

Investors, then, need to be aware of water scarcity as a key factor impacting a mining company's success in operating or exploring in such challenging operational environments.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: Investing News Network is a team of freelance writers and editors who provide regular content for mining and energy investors. This article was written by Vivien Diniz, one of our editors. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.