Fabio Buckeridge Brian Gillespie Stephen Loadsman November 2010‘The global financial crisis brought cost management back into focus for ‘many mining companies who for the previous tow years had been chasing production volume to exploit the booming commodity prices, Over the past eighteen months, many mining ‘companies have made radical changes to their mine plane as they reacted frstly to the intl slump in commodity prices In 2008, then almost as quickly had to lift their production targets when the slump in demand faled to materialse and prices started climbing again. Many mining operators effectively fx ir mine plans and budgets on an annual basis and often there are poor linkages between the mine plan, the budget and the real drivers of cost and value, Such operations struggle to determine the cost and margin impact of significant changes to production particulatly when this occurs outside the annual planning process. However, those mining companies that did understand the cost and value drivers were able to quickly respond to both the sudden price collapse and the recovery. Active management of the divers of cost across all areas of mine production and processing allowed 2 few mining operations to increase ‘margins throughout the boom-bust- boom cycle of 2008-2070. This paper seeks to demonstrate that robust ‘modeling of operational cost and value drivers across the extended if of mining operation is a key requirement for maximising value, regardless of the economic eyele.A. Return to cost efficiency ‘The global financial crisis highlighted the need for greater operational cost efficiency for ‘most mining companies. When commodity prices and demand collapsed in June 2008, many mining companies had to scramble to quickly reduce both production and unit costs following several years of prioritising operations to increase production volume. ‘At many mining companies, operational efficiency had been compromised in the quest for increased production volume to take advantage of spiralling prices. Most mining cost indices indicate that around the world, mining costs have indeed fallen since the commodity price collapse and have continued to fall while prices and volume demand have recovered. PwC estimates that operating expenses decreased by 6% from 2008 to 2009 across the global mining inéusty. However, despite ‘the significant decrease in operating expenses, a step-change reduction in the cost base remains elusive for mary. Itcan be dificu to find quick cost reduction opportunities when investment in plant equipment and ‘transport contracts are geared to a relatively narrow range of production volume, For many mining operations, reducing production volume may significantly increase extraction, processing and transport costs per Unt of product. The ablity to find short ‘erm cost savings through immediate production decreases is therefore often dependent an the operational abilty to make a step change in equipment and ‘transport utlsation accompanied by the same level of step change in cost. This requires both an appropriate set Up at the mine and extended production chain coupled with ‘he ability ofthe mining company to properly cost the changes to that production volume. Figure 1: An example of commodity price and mining cost 10,000 | — copper Pace ust nt) 19,000 | —US Ming ost hen sh 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 ° 1997 1998 1998 2000 2001 4 Optiising extended mining operations 2002 2008 2004 2005 2006 2007 2008 Many leading mining companies understand that operational cost cfficiency is an area that requires focus over the longer term to maximise Ifetime asset efficiency and embed a culture of cost awareness that will survive throughout boom commodity cycles. One indicator of a strong focus ‘on sustainable cost controls an ‘established allocation of key performance ingicators measuring ‘cost rather than volume or margin. BHP Biliton’s philosophy of allocating ‘cost, volume and safety accountability at the mine operations level through a standard set of performance measures focuses attention on long run ‘operational etficiency independent of prevailing or forecast commodity prices. BHP Biliton aggregates their marketing and sales function across all production and has an independent set ‘of performance indicators geared towards meeting (or exceeding) spot prices. n tis way, BHP Bilton maintains a long term focus on cost ttfective mining operations without any masking of performance by fluctuations in commodity prices. 140 130 120 2008B. Linking Operations and Finance Finding EBIT maximising __otfectvely configure requred opportunities production. Building an accurate ‘operational model where all Most mining compares focus primary components ofthat model ink tothe Dart aati td ‘on achieving operational and cost Cette operational model efficiency improvements at the mine __ straightforward way to combine Pee eee site level. Often the main metric used to operations and finance. is quantify the success of any cost Deca tla etficioncy intatve isto measure the __‘Thebest models provide cascading |/P MEN EE ae nominal cost saving using the standard _top down view of operations, liking costs detorminedin the previous __—high-levelfinancial outputs tothe key (Beles asi ast annual budgeting process. Sometimes operational rivers of tose outouts/ | NEU REND Py any itcan be mary months or even the” suchas production performance P financial yearend before te real motics and the cisaggregated Dra Roa Ld financial impact of operational operating costs of each major process | UP etn ts! efficiency initiatives can be measured. or asset. Those models are called value iver models and a tulle description ot | Ubsbteebnsn Mining companies must have a solid the theory and practice of building a Understanding of the operational levers value diver model can be found in the ‘hat drive financial performance if they PC paper published by Carter, want to be able to quicklyand cost. Giese and Gilbert (2009). Figure 2: Example of Value Driver Reporting PT Coptmising extended mining operations trough value driver modeling 5Value driver models can be used to il report a combination of operational Flexible value arc fnaeial performance data driver models ‘covering all aspects of a mining can calculate the ‘operation. The key difference from ‘more conventional reporting is thatthe expected costs under’ saiue driver model can be used to i ior present operating performance in a different production Poe teaing nec! src levels and operating disaggregating high-level reported financial performance into the lover performance level operational elements driving that scenarios. performance. A flexible value driver ‘model can calculate the expected ‘costs under iferent production levels and operating performance scenarios. Value driver models can therefore prioritise potential EBIT improvements by considering variation of many different operational configurations. Using value driver models within the budget cycle Mining organisations typically have proven ‘Life of mine’ planning processes and well defned budgeting teycles which use the production le Contained within the ‘Life of mine’ plan as a key input. However, the standard costs used in the budgeting process. are typically developed once per year as part of te annual budgeting cycle and are usually applicable to a specific production plan and therefore valid over a small range in targeted production. Typically there is no financial ink between the annual budget and the ‘Life of mine’ plan, Significant changes in target production usually involve a lengthy process involving several iterations of information exchange between mine management who produce new asset ‘configurations and the finance team ‘who cost them, For most mining ‘companies, this process has come Under increasing pressure since the beginning of the global financial crisis, ‘as mining companies seek a quick response to significantly changing ‘economic conditions. However, typically the adjustments to budgets ‘and forecasts or the identification of EBIT improvement initiatives require the budget process to be repeated to ‘ensure all key assumptions are ‘considered and the financial impact of the proposed changes are reliable, ‘Therefore it can take some time (often several weeks) for a financial impact to be estimated. properly configured value diver model can determine the financial implications of racical what if scenarios very quickty, allowing ‘senior management the ability to investigate significant changes in production levels or wider operational ‘configuration without lengthy iterations between the mine managers and finance team, Production scenarios that can take weeks or months to ‘cost can often be accomplished in a matter of hours. PwC have also found itto be the case that a value driver model once implemented, can typically provide the output used as the starting point for the next planning and budgeting cycle. Flexibility around production targets HET Rees Mies om te Cts t met since the beginning of the global ET e Meg Re Cme baleen enor Tay Sool ae Me (UC Scop rloveremCen Sea nteeceTa hy Cavt-ryarere amor roniCeraco tel lelo ee {6 Optimising extended mining operations through value diver modelingC. Optimising mining operations across the production value chain The challenge of end-to-end supply chain optimisation For those mining companies that have ‘managed to link operations and finance at the mine site level, the next Challenge becomes that of extending ‘those linkages across the production vvalue chain. The production value chain is often described as the ‘pitto- port operation’ but in realty this involves all aspects of the supply chain from the mineral extraction at the mine site through to the point at which the mineral is delivered to the customer. Only a few mining companies have ‘managed to implement a planning process that optimises operations across the full production chain from ‘the mine site to the customer. Most mining companies focus primarly on achieving operational and cost efficiency improvements at the mine site level. Often the main metric used to quantity the success of any cost reduction is to measure the nominal Cost saving using the standard costs from the previous annual budgeting process. However, the effects on the extended supply chain are often ignored or crude financial estimates are made by extending the nominal ‘cost saving over other parts of the value chain. Sometimes it can be many months or the end of the financial year ‘eefore the rea financial impact of ‘operational efficiency programs can be measured. End-to-end supply chain optimisation is well established in many other industries so it may seem strange that there are few mining companies that have managed to implement robust ‘optimisation planning tools across their {ull production supply chain. Although the typical mining supply chain looks to have only a few major components, ‘each component has significant operational complexity and has massive potential for variation on both capital items and operational expenses. Mining companies are dealing with hugely fluctuating prices for the ‘commodities they produce and also for many of their input costs. This Figure 3: Simplified Mining Supply Chain SB EE Eo Es + v + produces discontinuities in the cost and revenue functions of any supply chain model that ties to deal with step changes in many areas of the production supply chain, ‘The logical mining supply chain gives ro indication of the complexity that can arise within each component of the supply chain, For example, the rail ‘transport process can involve sharing infrastructure with transport providers and other mining companies and also involve complex scheduling which is further complicated ifthe system is suffering capacity constraints. Most mining companies prioitise the ‘optimisation of those parts oftheir supply chain that seem to have the largest operational cost, typically in isolation from the rest of the supply chain. However, optimising the operational efficiency of just one component of the supply chain may have ile or no effect on overall cost efficiency, particularly i the constraints of the supply chain are to be found elsewhere. Coptmising extended mining operations through value dever modeling 7Anexample of isolated decision making For example, take the situation where a rmine manager makes the decision to slow down development and longwall speed to meet a reduction in production targets. For this particular mine and extended value chain, slowing down development units may have little impact to overall production costs due to such things as fixed conveyor capacity, a longwal already ‘operating at low utilisation or contracted rail capacity that must be paid for regardless of the tonnage carried. Aaa) sfuly developed extended value driver models is Xstrata, ‘operations from mine to loading Pour ue ec} pee tee ng rd rica Cae cca) pee aan Rescue aan teed ey Peron ta See ret eet Ree eee Se ry Se eo 5 Optimising extended mining operations In this case, although the standard ‘costs in the mine plan andl budget indicate substantial cost savings, the reality is that ite or no cost saving may occut. In this case, stockpiling ‘excess production may have been a better interim option while major asset reconfiguration options or haulage ‘contracts were investigated, It may ‘even be the case that this decision actually was a negative diver of value ‘due tothe lost tonnage combined with zero cost saving. Clearly in tis case, the mining company may have benefited ithe mine manager had been able to quantity the real cost impact of the slowciown in development and longwall speeds. Figure perational Building avalue driver model across the full production value chain Understanding the linkages between cost and operational configuration in ‘each component of the production supply chain are the building blocks of value driver model that can be applied across the production process. The most useful operational models are those that replicate the full structure ‘of operations and process logic across. the extended production and supply cchain operation, This is not an easy task and involves comprehensive ‘mapping of operational actvties and their cost components as a first stage. : The value driver model build process ProductionD. Optimisation across extended mining operations Obtaining a full production value chain chain makes it increasingly ifficult company to align production capacity perspective of each mining operation isto estimate the aggregation effect 10 the level of overall demand at an ‘the frst step in identifying the value towards the end of the supply chain. optimum cost. A portfolio level view of drivers aoross the entire portfolio. To Small increases in production over__—_operations and respective operating obtain a robust portfolio view of all short periods at different mine sites for costs, gives management the tools to operations, any shared processes or example, can aggregate to exceed make portfolio decisions about infrastructure must be properly inked crushing capacity, stockpile capacity production levels. Ths is particularly Inthe value crvermodeLAporiolo or convacedallcapacy leading to production vel This Vowalone cor ocinesto. Sigurt aaiond oo. irpatart winnaar Unde’stand the diferent options available to them to achieve target Having operations and their below budgeted production which production levels across the full asset _interdependencies incorporated into often renders budgeted cost Portfolio. This provides divisional ‘one model allows management to assumptions meaningless for costing managers or mine general managers quickly estimate the impact of one new production levels. This allows the capability to understand the Yariable change on the entire portfolio, _ management to answer questions like: financial impact of ther operatonal Ths capaby is extended o What should our prodton porto Goctions onthe entre company. operational captal and statagic _—_‘lookIke f prices rao by 20%?" or poriolo This is parteuiarly mportant decision aking, Having aporfolo “where should we redce production where the complexity of the supply _view of operations allows a mining ‘our customer demand falls by 35%2" Figure 5: Example output from value driver model across an extended mining operation. Sensitivity analysis Value Drivers 1.00% 050% om 050% 21.00% RallLosd Out Facity Canscty Processing Plant Shut Downe Longwall Operating Delays Dragine Maintenance Delays LongwllCnange Out Time BIT impact of + 5% change operational value over ‘Truc Feat le Tone EIT impact of 5% change Frcaviter ect ale Tre operational value diver Coptmising extended mining operations through value dever modeling 9Figure 6: Value driver model of extended mining operations In Qu and, Australia, Xstrata Coal have implemented value driver models for all their mining operations and then linked those parts of each model that are also linked in the physical world, such as shared 's, preparation plants and stockpiles, EERE TVS pn octane rco aT RAS ene NCR cept p EME NCO Sore 10 Optimising extended mining operations through value diver modelingE. Rapid build of value driver models for mining operations Atool for rapidly building value driver models Itcan take a significant period of time to build a complete value criver hierarchy forall assets and activities in any particular mine and then allocate all fixed and variable costs to those assets and activities. Building a value fiver model from a zero base for a new mine site can take approximately 6-12 weeks, longer for extended mining ‘operations or when dealing with a new accounting system, Beyond the major differences between ‘open cut and underground mining ‘operations, the mining value chain employs a faitly standard set of assets and processes, PwC has developed a Microsoft Excel based software tool named Archimedes FACX which contains a library of mining activities, assets and chart of accounts that can be used to build a base model of any mine site and asset portfolios. Archimedes FACX folows structured value driver model build process and runs from a graphical user interface allowing rapid construction of a prototype value driver model. Customisation of any element of the mine operation that ciffer from standard mining processes can be undertaken in minutes. Archimedes FACX also has the Capability to download the general ledger for the mining operations being modelled and undertake predictive mapping of all cost accounts to accelerate the process of cost mapping. Typically over 80% of all cost ‘components can be predetermined using text based recognition of cost centres and accounts, This feature significantly reduces the time demands Con the finance team and mining ‘operations tearn which can often be the main constraining factor. Manual allocation of remaining cost ‘components and manual verification of ‘automatic mappings however are required to ensure that the value criver modelis complete, Archimedes FACK has reduced the time taken to produce ‘value driver model from 8-12 weeks down to 1-4 weeks, This significantly reduces the time taken to produce the first results, often providing immediate cost saving opportunities. Typically over 80% of all cost components can be predetermined using text based recognition of cost, centres and accounts. Coptmising extended mining operations through value driver modeling 11Figure 7: Building a value driver model using Archimedes FACK Archimedes FACK. 12. Optimising extended mining operations through value diver modelling| Benchmarking operational and financial performance 5 [Reomai-tem=—] | Once key valve crivers have been [x-Oper cxrbrcimans =] identified, benchmarking can also be Siereneien > Senn Undertaken across a company’s other ire sees con src cend mining operations and also against teem recente! al] RotonecrieaperTe ‘comparable performance of ather mining cwieren ter Ey nmr ee operations, PwC has now developed a By) onnren library of operational and financial “oe metie for large mining operations that q can be used for comparative external Sonnan reer benchmarking, These benchmarks have Cooma wn] been colatad over several years of ‘operational improvement projects with fo ft top tier mining companies in Australia. ‘These operational and financial on ee co benchmarks are also contained within the Archimedes FACX software tool Figure 9: Example benchmarking output in Archimedes FACK 140 120 Development Cost ($ per metre) 8 . . © Benchmarks ° Hi Mine boing modelled o 1 2 8 4 6 6 7 8 98 Production ('000 tonnes per annum) ‘Optimising extended mining aperaions through value ever modeling 15F. Conclusion Intesporse to anew eraof rapidly Acknowledgements fluctuating prices and demand, mining companies now require o be ‘This paper has boon developed considerably more flexible in their _folowing insights gained by PwC while approach to cost optimisation of Working on operational improvement rmining operations. Robust modelling of projects with Anglo American, BHP ‘cost and value across the extended —_Biliton, Xstrata Coal and Xstrata ‘operations of armining company isa Copper. Sean Miller of Xstrata Copper, key requirement for maximising value Rebecca Philips of Anglo American regardless of the economic cycle, ‘Metallurgical Goal and Mark Producing value driver models for ‘MacManus of Xstrata Coal all took extended mining operations is one __the time to provide us with valuable ‘method to quickly investigate potential insights to the realiies of thelr mining cost reduction or EBIT maximising operations. ‘opportunities across the extended ‘mining supply chain, (Our special thanks to Xstrata Coal who engaged us to develop value driver ‘The time taken to build value driver models for heir coal operations in models for extended mining operations Queensland and have allowed us to can also be improved significantly reproduce some material developed ‘through the development of libraries of while working on their projects. mining assets, processes and cost ‘elements which allow rapid “Thanks also to our PwC colleagues; configuration of models of new mining Aaron Carter Toronto office), Chris ‘operations. A portfolio view of ‘Melck and Xing Lui (both Brisbane) extended mining operations provides who worked with Fabio on the senior management with the capablity development of the Archimedes FACX ‘to understand the financial impact of software tool and contributed many of ‘their operational decisions on the entire the ideas contained inthis paper. ‘company portioto, Forested ‘Aaron Carter, Brian Gillespie and Chris Gilbert, February 2009, Finding cost efficiencies or erga eae 2007. “Mining sector has to formalise processes and systems to Penta AC ee ae ie a ear ee ee Recent Plant Operators Forum 2004, Colorado PricewaterhouseCoopers, 2010, “Mine: Back to the Boom Review of global trends in the See en ees ete ns PricewaterhouseCoopers, 2008, “Finding cost efficiencies in mining operations through meet eee} 14 Optimising extended mining operations through value diver modelingAbout the authors Sco Brian Gillespie Stephen Loadsman Fabio Buckeridge Partner Director Senior Manager Tel +81 7 9257 5656 7.4817 9257 8304 Ti +61 7 9257 8354 E: brian.gilespie@au.pwe.com E:stephenloadsman@aupwe.com —_E: fabio.buckeridge@au.pwe.com Brian's a Partnerwith PwC in Australia Stephen's aDirectorin PwCin Australia Fabio isa Senior Manager in the PWC leacing Strategy and Operational leading projects inthe Resources sector _Consuiting practice in Brisbane. He Improvement assignments for Resources where he specializes n corporate specialises in operational improvement and companies. In recent years Brian has performance management, finance c08t reduction anc has led multiple value Worked ona diverse range of projects —_affectiveness and cost reduction. shiver modeling assignments. Fabio has 8 across the mining, ollanégas sectore Stephen has led various value cever Years of international Resources sector such as hedging strategies, logistics and modeling, KPI defintion, management __experience and has knowledge of electrical supply chain optimisation, credit risk, reporting, capital efficiency, and engineering, logistics, mining, accounting safety, major feasibility strategies, ‘operational planning and forecasting and finance. He has worked in South organisational re-structuring and process assignments across Australia, UK.Asia, America, USA, UX and Australia, improvement (Canada, South America, Fiji and PNG. In recent years Fabio has managed large Brian has led large projects with In recent years Stephen has led ‘operational improvement projects for Anglo ‘Anglo American, BHP Bilton, Ro Tinto, assignments with BHP Bilton, Xstrata__——_American, BHP Billton and Xstrata. Fabio Xstrata Coal, British Gas, (Copper Xstrata Coal, Anglo American, ‘has experience across several Santos, Origin Energy, Dalrymple Macarthur Coal, Newerest, YanCoal, commodities and has recently managed Bay Coal Terminal and Queensland Rall Santos, and Queensland Rail the implementation of value driver models Coal Division Stephen holds aBachelorofBusiess 27088 al XEata Coa mie tes in Queensland, Australia. Fabio holds @ Brian holds the degrees of BSc and (Accountancy) from Queensland University guSnTeens nance snd accmentng (ist Mba anes CharoesErgneer Teena adie achared Bechet ance and cern it WihnensittestErgrecingess —Recaumtarcuinthehemecfenarered je Seo fem te Cue Technology in the UK. Accountants of Australia Chartered Accountant, with the Institute of Ghutred Accra Asal Contacting PwC usta tory nd nwt Knaton come Amwalan nd Gosling Lencer Serpe Pmt ee 1ses 25 Enc Seengero pe zom rata IcowterheuneCoops, Ronde Ce 123 Eagle Steet, rebane OLD 4000 Canada Hugh Cameron, Johannesburg Paul Murphy, Toronto Telephone: 127 14 797 2282 {GPO Box 160 Brisbane QLD 4001, Australia Telephone: +1 416 947 8242 Email hugh cameron@za pue.com Otc: +81 73257 8995 malt paul mrphy@ea.pne.com Facsimile: $61 73023 0936 Website: ww pue.comau