Business Overview & Strategy | Principal Risks and Uncertainties
The risks set out below represent some of the principal uncertainties and trends which exist in Xstrata’s business and which may have an impact on our ability to execute our strategy effectively in future. Xstrata’s risk management policy is available from our website. The following risk information is not intended to be a comprehensive overview of risks inherent in Xstrata’s business.
Commodity prices
Xstrata’s revenue and earnings are dependent on prevailing prices for the commodities we produce. Commodity prices are determined by the supply of and demand for raw materials, and are closely linked to global economic growth. North America, Asia and Europe are particularly important markets for Xstrata, accounting for almost 90% of 2006 revenues on a statutory basis. Xstrata produces and sells both exchange-traded commodities and commodities where prices are negotiated on longer-term contracts. Commodity prices for all products, and particularly for exchange-traded commodities, may fluctuate widely and may have a material impact on financial results. The impact on Group earnings (EBIT) of movements in the price of each of Xstrata’s commodities is set out in the EBIT Sensitivities table in the Financial Review. Commentary on the trends in each of Xstrata’s commodity markets is provided in the Markets section of this report.
We manage the risk of commodity price fluctuations through maintaining a diversified portfolio of commodities and typically do not implement large-scale strategic hedging or price management initiatives. We also aim to reduce costs on a continuous basis and maintain low-cost, efficient operations, optimising our portfolio and returns throughout the commodity price cycle.
Currency exchange rates
Concentrator Technicians, Colin Jensen and Vic Kandiah, between shifts at Ernest Henry copper mine, Australia
Xstrata’s products are generally sold in US dollars, while our operations and operating costs are spread across several different countries and currencies. Fluctuations in exchange rates, in particular, movements in the Australian dollar, Canadian dollar and South African Rand against the US dollar, may have a material impact on Xstrata’s financial results. The impacts of currency exchange rate fluctuations on Group EBIT, together with average exchange rates, are set out in the Financial Review.
We manage this risk through maintaining a diversified portfolio of assets across several different currencies. From time to time we may also hedge a portion of our currency exposures and requirement, to try to limit any adverse effect of exchange rate fluctuations. Foreign currency hedging information is provided in the Financial Review.
Integration of acquisitions
Xstrata has grown primarily through the successful completion of a number of large-scale and smaller acquisitions and through the subsequent improvements made in the performance of businesses acquired. Acquisitions and investments in joint ventures will continue to be an important part of our strategy and involve a number of risks, including the risk that businesses acquired are not integrated effectively or that anticipated cost savings or synergies are not realised.
Over the past five years, we have developed significant capability and a strong track record in effectively integrating large-scale and smaller acquisitions and investments into Xstrata’s corporate structure. In each case, acquisitions have been quickly and effectively integrated, realising operational, financial and strategic improvements and greater than expected cost savings or synergy benefits.
Project development
Continued robust demand for mining products has resulted in significant inflation in the cost of labour, fuel, raw materials and other key mining industry inputs, together with increased lead order times for key items and equipment. As a result, the delivery of major projects on time and within budget is increasingly challenging. Through the acquisitions made in 2006, Xstrata has a significantly enhanced pipeline of growth projects across a number of countries.
Xstrata’s commodity businesses have an excellent track record of delivering major capital growth projects on time and on budget, including the successful commissioning of five major growth projects in 2006 in a very challenging cost environment. In addition, Xstrata’s existing capabilities have been complemented and broadened through the retention of a significant pool of project management expertise from the former Falconbridge business. Cost control remains a key consideration for any project development.
Health, safety and environment
Xstrata’s operations are subject to extensive health, safety and environmental regulations and legislation, community expectations and to the best practice standards set out in our Sustainable Development framework of policies and standards. Our commitment to the principles of sustainable development, which incorporates environmental, economic and social performance, is an integral part of our operating philosophy.
Progressive rehabilitation taking place at Newlands coal mine, Australia
New or amended environmental, health and safety legislation or regulations may result in increased operating costs or, in the event of non-compliance, the possibility of fines, penalties or other actions which may adversely affect Xstrata’s financial position. Rehabilitation costs, which are generally estimated and provided for over the life of operations and based on the best information available, may subsequently increase, impacting on Group earnings. Any breach of regulations or non-compliance with Xstrata’s own best practice standards in health, safety and environmental performance and community relations may damage our reputation and, as a result, our licence to operate.
The most significant health risk facing the Group is the impact of HIV and AIDS on Xstrata’s South African workforce.
We have implemented a comprehensive voluntary testing, counselling and treatment programme across our SA operations. Further information is provided in the Sustainable Development section on pages 96 to 100.
Every managed operation is independently audited through the Xstrata HSEC Assurance Audits on a regular basis, to provide assurance to the Board that our Group HSEC standards are being met or exceeded. Within 100 days of acquiring Falconbridge, rapid assessments had been completed of every Falconbridge site, identifying areas of underperformance and where additional investment is required. A key priority for 2007 will be to implement systems and improve the performance of the former Falconbridge operations to a satisfactory level.
The acquisition of Falconbridge substantially increased the number of closed sites being managed by Xstrata. Through the integration process, the management of closed sites was reviewed and these sites are now the responsibility of the respective commodity business management teams, encouraging a more integrated approach to rehabilitation and closure planning and management.
Climate change and energy
Xstrata operates in a number of jurisdictions in which regulations or laws have been introduced to limit or reduce greenhouse gas emissions. While it is impossible to quantify the impact of the Kyoto Protocol and related legislation and regulation at this time, the likely effect will be to increase costs for fossil fuels, electricity and transportation, restrict industrial emissions, impose added costs for emissions in excess of permitted levels and increase costs for monitoring, reporting and accounting.
A number of Xstrata’s operations are intensive users of natural gas, electricity, oil and other energy sources. Significant increases in energy costs or restricted supplies of energy sources due to climate change legislation or other reasons may have a material adverse impact on the Group’s ability to maintain production and/or contain operating costs. A significant proportion of the Group’s costs relate to energy consumption and programmes are in place across Xstrata’s operations to reduce energy intensity and achieve cost savings.
As the world’s largest producer of export thermal coal, Xstrata is playing a leading role in actively investing in research and development projects to reduce greenhouse gas emissions from the use of coal in power generation, together with other coal producers, governments, scientific and academic organisations. Demand for coal is expected to be supported by forecast significant increases in global demand for energy, particularly in developing countries, and by coal’s relative cost position, availability and security of supply. However, any material decline in the use of coal as a power source as a result of carbon taxes, emissions trading or similar legislation may have a material adverse impact on Xstrata’s financial position.
Operator Pat Kopittke at the anode scrap machine control panel, Townsville copper refinery, Australia
Political and community
Xstrata operates in a wide range of countries, including in some countries that may be considered to be, or may become politically or socially destabilised. Political risks include changes in laws, taxes or royalties, expropriation of assets, currency restrictions or renegotiation of or changes to mining leases and permits. Similarly, communities in certain regions may oppose mining activities for various reasons. Any of these factors could have an adverse impact on the Group’s profitability in a certain geographic region or at certain operations.
We perform a thorough risk assessment on a country-by-country basis when considering our activities and investments and regularly review country risk to ensure that political, regulatory and social risks have been properly identified and are within acceptable levels. We aim to work closely in partnership with local communities for mutual benefits, earning and maintaining a social licence to operate. We further manage this risk through maintaining a broad geographic spread of assets, ensuring that political risk is spread across a number of territories.
In South Africa, the Mineral and Petroleum Resources Development Act (MPRDA) and Empowerment Charter sets out the requirement for all existing prospecting and mining rights to be converted into “new order” rights. To achieve this conversion, or to obtain “new order” rights for new applications, mining companies must satisfy a number of criteria.
These include the requirement for 26% of South African mining assets to be controlled by historically disadvantaged South Africans by 2014, and other requirements which aim to achieve broad-based black economic empowerment in the industry and more general social upliftment of previously disadvantaged persons. If mining companies cannot fulfil these criteria or provide satisfactory undertakings, existing rights may become invalid, potentially having a material adverse impact on operations in South Africa.
To date, Xstrata is the only major mining company to have satisfied our ownership requirements under the MPRDA. Our South African businesses have entered into partnerships with African Rainbow Minerals (ARM), the Bakwena Ba Mogopa Community, Kagiso Trust Investments and Merafe Resources to facilitate ownership and management participation in our operations. Good progress has also been made in a number of other areas, including in increasing the proportion of procurement from black economic companies, helping to establish small and medium black-controlled companies and increasing the proportion of black and female managers within the business.
Operational risks and reserves and resources
Xstrata’s operations may be impacted by a number of circumstances including natural disasters, unexpected geological or technical difficulties, labour disruptions, environmental or safety incidents, causing increased costs, lower production or the suspension of operations. Exploration initiatives and the acquisition of new resources may not succeed and existing reserves may not be replaced or increased. Reserves and resources information also relies on a number of estimates and assumptions which, if materially inaccurate, could impact on our financial position and asset values.
Our strategy of “near-mine” exploration and partnering with juniors has resulted in a number of resource extensions in 2006. Operational risks are identified and managed through Xsrata’s comprehensive risk management programme.
Demanufacturing of a cathode ray tube in a recycling facility