What if we had to shut for three months?

2020-06-04T09:49:38+00:00 June 2nd, 2020|Country in Focus, News|

By Prof Frederick T Cawood, director: Wits Mining Institute.

Covid-19, or more broadly, the spread of an infectious disease, is not a new issue for mining. This issue has been on and off mining agendas for some time.

[Please note that this article was written mid-March before the level-4 lockdown measures were announced. It is interesting though, as it gives us an idea form how long mining companies can continue without production, should there be a second wave of infections, or in preparation for future events of a similar nature.]
Digging dirt in South Africa. The mining industry in South Africa will only be able to survive three months without any production. Image credit: Leon Louw

Digging dirt in South Africa. The mining industry in South Africa will only be able to survive three months without any production. Image credit: Leon Louw

The Ebola outbreak in West Africa and high rates of malaria, HIV and Tuberculosis infections at African and South African mines elevated the issue to prominence. The big question currently is this: is the Corona virus in 2020 one of those major events that could lead to the fall of a government or an industry?

Such a doomsday scenario depends on whether or not government and industry have the cash to prop up the economy and operations. Cash (or capital) normally comes from loans, investors and earnings. The proportions depend on the risks involved, capital availability and cost of the capital. Despite good growth in foreign direct investment (FDI) in the rest of Africa, investment capital in South Africa was already scarce before the crisis, and post-Covid-19 will be worse. Post-Covid-19 debt will be harder to secure and will be more expensive. UNCTAD1 estimates that Covid-19 will cause capital globally to shrink by 30% to 40%, with company earnings likely to be down 30%. With national shutdowns now the norm and the South African lockdown extended, companies are rightfully concerned about where earnings will come from. At the same time, they are supportive of the greater public health imperative to limit the spread of the disease. Trying to predict post-Covid scenarios requires assumptions like these:

  • There will be no vaccine available within the next three months;
  • Covid-19 will not be eliminated within the next three months;
  • Spreading of the disease will happen in waves with not all areas will be affected equally; and
  • Widespread testing for the virus will allow interpretation of patterns.

First shutdown (March/ April 2020)

Prof Fred Cawood -Director of the Wits Mining Institute. Image credit: Jeremy Glyn

Prof Fred Cawood -Director of the Wits Mining Institute. Image credit: Jeremy Glyn

Understandably, with limited data on Covid-19, most governments opted for a total shutdown to control the spread of the disease. Such a lockdown incorrectly assumes that all areas are equally affected at the same point in time. This onesolution-fits-all gives policy-makers time to develop a better approach to manage the situation.

The shutdown caused a paralysed economy with no production, no earnings and no growth. In the scramble for some remote productivity, companies have introduced virtual workflows with flexible service models. While it works for ‘services’, production requires physical presence – unless it is automated to the point that it can be done remotely. Although the April shutdown will squeeze margins, most large firms have plans in place to keep afloat for a few weeks. According to PWC SA Mine2, the industry had R32-billion free cash flow in 2019 and assuming all expenditure on consumables, transport, royalties and exploration stop with immediate effect, this cash will last just over one month for the total industry. All companies are different, but it is almost certain that some (smaller) companies will experience hardship in the first month of zero production.

For the larger companies, executives and shareholders will start sacrificing income, while workers at smaller firms will start losing their jobs. In addition, some companies understandingly must declare ‘force majeure’, with the official lockdown (an unforeseeable circumstance at the start of 2020) preventing them from fulfilling their supply and other contracts. To conclude, cracks are appearing within the first month of lockdown.

Likely scenario after two months of shutdown

Continued paralysis in production is the most feared scenario presently. Larger firms with accumulated earnings or access to capital will cope for a bit longer than medium-scale mining companies, who will go under in the second month of no production. With an average EBIDTA margin of 25% and aggregated cash making up 16% of assets in 2019, some more South African mining companies will go broke after two months of no production (‘losing’ 17% of the year. This will be a time of significant restructuring of portfolios and mass lay-offs. After two months of shutdown, the mining industry will show signs of ‘failing’. To conclude, after two months of no production most small and medium-scale South African mining companies will go broke, with their workers and their communities. If lockdown continues beyond this, it will tart affecting the sustainability of larger firms.

Three months of shutdown

Assuming that only necessary operating expenses continue, the total aggregated cash of R70-billion for the industry will  be depleted after three months. In a paralysed economy, only those companies with access to more capital will be alive. This is the doomsday scenario that we all fear, which will trigger the fall of the South African mining industry, as we know it. This is not where it stops, because once the industry’s domino falls, other dominoes will also fall, including the state. For the state to ‘prop-up’ the economy, it needs income and many governments in Africa simply do not have the cash to prop their economies. While society can probably do without consumer goods for three months, governments cannot afford to lose their reliable and above-average income stream from the mining industry.

The chart below illustrates the contribution of South Africa’s mining sector to the national income – in relation to its tax contribution. It shows that the mining sector pays more than its fair share in taxes – in fact, it pays on average twice the rate of its contribution to the economy and therefore ‘subsidises’ other industries through a higher effective tax rate. A mining shutdown therefore has more impact on government than other economic sectors.

Figure 1- Raw data obtained from STATSSA Publications P0044 & P0441

Figure 1- Raw data obtained from STATSSA Publications P0044 & P0441

What can be done?

Shutdown in its current form must end and be replaced by a system that allows companies to generate earnings, while conducting robust risk management. The mining industry is familiar with managing multiple risks, and government policy makers can learn from mining in developing a pragmatic approach to manage the spread of diseases. This experience with risk management and the fact that mining occurs mostly in remote locations, means that the industry is more prepared for managing the spread of infectious diseases than most other
economic sectors.

The objective is simple: keep the mines going and stop the government from failing. For this to work, testing must continue but the objective must change from testing that justifies staying at home to testing that allows people to work. Sharing of information and equal access to communication will be critical for trust in such a time.

  1. UNCTAD Investment Trends Monitor – Corona special update March 2020. Available from http://www.unctad.org
  2. Source PWC SA Mine 2019: In transition. September 2019, 11th edition. Available from pwc.co.za/mining.