A rally in commodity prices in the second half of 2016 was a welcome break for the mining sector. However an upturn in the fortunes for mining companies carries with it implications for risk profiles and insurance cover.
After a run of low commodity prices, the mining sector saw what it hopes are the first green shoots of recovery in 2016. Prices increased across a broad range of commodities, boosted by demand from China and in response to political upheavals.
Coal was one of the best performing commodities – the price of metallurgical coal, a key ingredient in steel making, peaked at over USD 300 per tonne from just USD 80 per tonne at the start of the year. The price of iron ore rose to almost USD 80 per tonne in November, a 100% increase on the start of the year.
The surprise rally in commodity prices at the end of 2016 has reignited exploration activity and is expected to lead to an overall increase in production.
With higher prices, coal mines in Australia, Canada and Mozambique, - mothballed when prices were below USD 100 in 2015 – have been bought back into production. Two of the world’s largest mining groups (BHP Billiton & Rio Tinto) have said that they expect to see increases in both metallurgical coal and iron ore production volumes in 2017.
Increased business interruption values
As the mining sector changes gear to take advantage of higher prices, companies need to keep an eye on their business interruption (BI) exposures.
The combination of higher commodity prices and the benefits of cost discipline in recent years are causing BI values to rise for the first time in several years. Mining clients should therefore work with their broker to ensure that insured business interruption values accurately reflect today’s commodity prices, while allowing for potential future volatility.
Reducing limits in the current soft insurance market could therefore prove short-sighted. Premium savings will be marginal at today’s prices, while such a move could prove costly in the long term as it will most probably be more expensive to reinstate higher policy limits once commodity prices have risen or if the insurance market takes a hardening turn.
Between Brexit, Trump and a more assertive Russia and China, it is prudent to expect a period of continuing political and economic uncertainty.
Despite cautious optimism over prices, political and economic uncertainty could result in further volatility for commodities. In 2017 the price of metallurgical coal has already fallen back to around USD 220 per tonne with talk of increased supply, but is still over 178% above the January 2016 price.
Other commodities experienced price volatility in 2016 as they reacted to changes in the political landscape.
The price of gold, traditionally a safe-haven commodity, spiked on news of the UK’s vote to exit the EU, but fell on anticipation of a Trump-related boost to the US economy, before rising again in January. Copper prices also rose following Donald Trump’s election victory in November, reflecting the new president’s pledge to invest in infrastructure.
It is worth keeping in mind the potential impact from natural catastrophes, especially when prices are rising. Both commodity prices and production volumes are affected by large natural disasters and the memory of the 2011 floods in Australia causing metallurgical coal prices to hit USD 335 per tonne is not a distant one. In recent years insured natural catastrophe losses have been relatively small but the risk of disruption from storms and earthquakes to mine operations, ports and supply chains remains.
Higher commodity prices will therefore have a material influence on the risk profile of mining operations and accentuates the implications of unforeseen downtime and outages. The financial impact of disruption increases with higher values, while operating equipment, process plants and, supply chains become stretched as pressure to raise production intensifies. Should the rally in commodity prices persist we can also expect to see increases in the lead-in times for spare parts – from haul truck tyres to mill drives – increase and competition for skilled workers is also likely to intensify.
For mine operators used to several years of subdued activity these will seem like problems to have; but to miss the rally due to poor risk management would be a cardinal sin in the eyes of investors. Mine operators should therefore review loss prevention and business continuity plans if they are to make the best of higher prices, while they last.
For further information, please contact Harry Floyd, Partner on +44 207 466 1305 or email email@example.com.