Examining the factors that will shape the resources sector of tomorrow, and how mining companies and professionals might evolve to meet the opportunities of the new environment
While we cannot rely on the past to predict the future of the resources sector, it is helpful to consider trends in the journey so far. A useful starting question that those who make their living in the Australian mining sector might ask is: why do the Swedes lead us in the global equipment sector? Australia, which is home to such a broad array of great mining companies, lacks the equivalents of Atlas Copco, Sandvik and Scania.
How natural resource endowments determine capabilities
First let us consider natural resource endowments. In Sweden, iron ore mining continues at the Kiruna mine almost a mile below the surface via sublevel caving methods. Meanwhile, underground iron ore mining would be unthinkable in Australia because, despite our high-quality reserves, open pit mining is far more feasible and familiar. One of our most famous mining towns, Kalgoorlie, was once home to fragmented underground gold mining, but became the home of one of the world’s largest open pit operations as ownership was rationalised and bulk open pit mining techniques redefined commercial opportunities. Since this time, Australians have excelled at surface mining of large, low-grade (especially gold) or low-value orebodies (especially iron ore). The Swedes excelled at mining iron ore, first via open cut techniques – Kiruna commenced in 1890 and Atlas Copco was founded in 1893 – and then via underground methods since the 1960s. They have had to drive technology to facilitate this. These contrasting business models reflect the choices in capabilities development necessitated by natural constraints. Resource endowments determine capabilities and types of work in the resource sector.
The Australian and Swedish situations reflect two different trajectories in capabilities development in mining and the mining services sector that have been shaped by resource endowments. The Swedish miners who started at Kiruna in the 1890s were eventually forced to find new efficient ways to mine, abandoning old skill sets for new, because that was the only way they could stay in the game. Competitive price pressure from low-cost producers drove administrators to turn to suppliers for innovations that would reduce costs, thereby stimulating the emergence of services and new intellectual property that proved to be internationally competitive. Australia is fortunate because we have diverse and rich resource endowments that necessitate a variety of mining methods (eg surface and underground, bulk and narrow vein). However, we have not specialised to the same extent because market forces did not incentivise it.
Market forces and incentives
Competition creates demand for new fields of expertise and eliminates old ones by way of ‘creative destruction’. During booms, when demand is strong and prices rise, the quest is generally for increased production capacity to meet the market’s ‘willingness to pay’. During busts, when prices slump, competition intensifies to reduce ‘supplier opportunity costs’ and increase productivity. In other words, managers facing sagging profitability will seek out low-cost solutions, adapting and applying the new alongside the old, as business models are adjusted to reduce costs. Anyone aspiring to a long-term career in the resources sector needs to be comfortable with these two mindsets and associated skills.
The cycle of booms and busts rejuvenates (and kills off ) capabilities as new business models emerge. As traditional, integrated mining companies have progressively outsourced dedicated activities to drive down costs – and are expected continue to do so – they have cultivated a wide array of specialised service companies. In a free trade world of low transportation and communication costs, capabilities developed in the services sector globalise; this disrupts incumbent business models and encourages global careers in mining services. Services-based business models will play a leading role in the resources sector and will shape the future of work by adding technical dynamism, disrupting career paths and, most importantly, facilitating knowledge transfer from other industries.
Together, resource endowments and competition drive the direction of innovative substitution. Peak oil, the widely publicised view that the rate of oil discovery will eventually fall behind the rate of oil depletion, illustrates what this means in practice. The logic behind ‘peak theory’ is that the reserves that are easy to discover and exploit will be found first, meaning it will become harder with time to increase supply. In practice ‘the peak’ has been far less steep than was originally feared, buying time for innovations and the emergence of substitutes. For example, gas displaced oil as a source of residential heating and for many industrial purposes.
Gas exploration and production has experienced similar competitive developments. As natural gas production in the US plateaued and international gas prices rose, shale gas production climbed to meet demand and captured market share from natural gas. Even within the shale gas category it is possible to see peaks and the emergence of new supplies of gas. From the Bakken to the Marcellus formations, the story of shale gas, like other peaking resources types, has been one of exploitation, expiration and replacement as innovation has enabled new substitutes to become available. Service companies have played a critical role in the development and adaptation of technology to cater to these new businesses. The size and sophistication of the service sector accelerates the distribution of these capabilities, sometimes sourcing ideas from outside the sector.
Innovations in exploration technology have offset declining reserves for other resource types during market booms, where demand has exceeded supply. If we consider the cost of base metal discoveries in the period from the 1950s to the 1990s we find that discovery costs have been more or less stable. Meanwhile, the same discovery costs for gold climbed from the 1970s onwards. The relative scarcity of gold has contributed to these escalating costs compared to the abundance of base metals – but that is not the whole story. High demand for gold and its short supply has facilitated high-cost exploration because the willingness to pay more for gold has enabled investment in new and often more expensive exploration methods, justified by scale and processing efficiencies. Meanwhile, the abundance of base metals, and their substitutes, has ensured that a healthy supply has kept prices and the appetite for exploration investment low.
During the recent mining boom, the industry saw new peaks in demand across many resource types. This demand increased willingness to pay and attracted investment that undermined productivity. McKinsey has shown that worldwide mining is 28 per cent less productive today than a decade ago, after adjusting for declining grades. The cause of this declining productivity is higher prices that allow break-even points to increase for mining operations. This allows relatively inefficient operators to prosper. When the price of resources falls, inefficient producers exit the market and, with their departure, productivity rises.
Resource booms are important because they provide economic surpluses to the industry, enabling investment in innovation. Investment allows for experimentation, and occasionally high-cost innovations, if they are adopted widely, become low-cost specialisation and achieve the status of an industry standard. In recent years the high prices of crude oil and iron ore prompted innovative revolutions that continue to be felt. Like the shale gas producers of the US, Australia’s Fortescue Metals Group is an example of a company that was able to reduce costs and increase productivity in time to survive the shakeout.
The link between innovation and growth
In order to understand what triggers innovations, drives the competitive landscape, and shapes career opportunities, we need a framework that will help explain the link between innovation and growth. If we chart the long-term GDP per capita of the US economy from 1870 until 2006 on a log-linear scale, we get a straight line indicating a long-term average growth rate of 1.85 per cent per year. Growth rises and falls above and below this figure with US business cycles, but the trend is otherwise well defined. Why? One answer is that long-term growth rates are limited by a ‘growth-factor defined innovation horizon’. A neat way to explain growth and its relationship with innovation is to draw on the ideas of Adam Smith, who attributed growth to three factors, which for this discussion, we can equate to population, specialisation and investment.
Population growth increases the demand for goods and services. This growth can be achieved through natural population expansion or through immigration. Another way to grow demand is through market access to populations in other countries, for example via international free trade agreements. All of these require innovation: social, political and legal. The significance of growing populations, especially the urban middle-classes, is that they drive demand and prices upwards. Meanwhile, increased demand enhances economies of scale – an especially important feature of resource industries that are generally capital intensive and rely on low marginal production costs. Free trading countries, like Australia, tend to favour scale-driven capital intensive operations and encourage competition from international mining and mining services companies. Those companies and individuals that manage diversity well will enjoy the best opportunities.
Specialisation is achieved by defining repeat processes for people and machinery. People are trained in techniques and skills that have been optimised and these ‘experience effects’ improve productivity. Automation enables machinery to replicate, replace or improve on routine activities performed by humans. Training and automation facilitate the codification of processes, which are the basis for management systems such as ISO. With an effective strategy, corporate bureaucracies efficiently coordinate resources and generate economic surpluses. These surpluses are maximised where employees and contractors learn to use machines, which amplify their capabilities and productivity. A company’s willingness to pay increases where the productivity gains are compelling and the supply is constrained. The emergence of services – an example of new business models based on specialisation – carved out activities from mining companies freeing capital, cash flow and management time for other more productive opportunities. In the future, as it was in the past, it will be those who learn to work with machines that increase the company’s competitive advantage who will demand the highest incomes. Those whose work is easily automated will need to develop a new – possibly related – skill set. Specialised skills developed for mining services may also find markets elsewhere and vice versa.
Investment requires judgement because investments, by their nature, are uncertain. Investment in new technology remains a largely human activity, aided and enhanced with machines, such as computers, which perform routine tasks better and more accurately than ever before. Machines also make decisions within predetermined parameters that have become more sophisticated in recent years. It has been suggested by Elon Musk that we face the prospect of becoming ‘house cats’ to artificial intelligence. We suggest that the advent of autonomous machines and artificial intelligence frees human resources for activities that cannot be performed independently by machines. Investments in human capital will create new skill sets and capabilities that maximise the full benefits of new technology, even artificial intelligence. Human ingenuity will remain central to investment decisions. Given the poor track record of investment decisions in the resources sector, plenty of scope remains to add value.
The optimisation of the three factors – population, specialisation and investment – sets the tone for the future of work in the resources sector. Australia’s resource endowments are diverse and we are home to wide variety of mining methods, which means that we will need to work harder to achieve world-class specialisations. Perhaps the fact that we have such diversity in our resource endowments, and hence professional workforce, is a speciality in itself?
The trends suggest that mining companies will become leaner and more specialised as more activities are outsourced. This means that the resource sector will need to improve by way of welcoming skills from other industries and cultures, both professional and international. The good news is that entrepreneurial opportunities in the resources sector will no longer be restricted to the few that have the capital to develop and operate a mine. The potential for professionals that can offer globally competitive services will be enhanced with the advent of improved technology, especially those guiding investment decisions. Identifying and investing in capabilities that optimise work with machines will enhance productivity and the value of your work. Market booms and busts each represent opportunities to augment and develop capabilities for the resources sector and beyond.