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Key Questions for Challenging Times

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KPMG’s Mining Executive Forum Fall 2013 Toronto, Canada

“It was a resolute group of mining executives that filled the conference room at KPMG’s 9th Annual Mining Executive Forum. These are not the best of times for our industry, to be sure, but the delegates came prepared to accept a challenge rather than concede a defeat.”

Keynote message

© 2014 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Jamie SokalskyPresident and Chief Executive Officer Barrick Gold Corporation

I would forgive anyone in the mining industry for thinking that gold companies had it made a few years ago. As global demand and prices for many metals were slumping, gold topped $1,800/oz in August of 2011.

At that time, none of us fully comprehended the impact of a trend that would play out over the next couple of years. Valuations for gold companies have eroded substantially. This has occurred even though the gold price remains historically high and its underlying fundamentals are still strong.

Part of the reason for this, of course, is the ability of investors to buy the gold ETF as an alternative to gold mining equities. However, the gold ETF is really a litmus test for the way we create value as gold mining companies. As an industry, we brought on many of our own problems by following an old axiom: produce more when the price is high.

With a rising gold price, gold companies began to chase more marginal ore at existing mines and develop low grade projects in more remote parts of the world where infrastructure is lacking, project costs are high and resource nationalism is more prevalent. Many investors didn’t want to take on those risks – not when they could directly invest in gold through the gold ETF.

The industry is now beginning to recognize that the single-minded pursuit of production was destructive to margins and valuations. At Barrick, we adopted a strategy over a year ago that brings more discipline to our capital allocation and is guided by a simple mantra – returns will drive production, production will not drive returns. That means shelving higher-risk, lower-return projects, concentrating on cost reduction, and focusing on free cash flow instead of production.

If the gold price should ever revert to historic norms, gold mining equities may naturally become more attractive than the gold ETF. Nevertheless, the industry cannot forget this lesson we have learned, and we must now outshine our own product in the competition for investment capital.


Key Questions for Challenging Times 1


2 Key Questions for Challenging Times

It was a resolute group of mining executives that filled the conference room at KPMG’s 9th Annual Mining Executive Forum. These are not the best of times for our industry, to be sure, but the delegates came prepared to accept a challenge rather than concede a defeat. Our CEO keynote speakers, Jamie Sokalsky of Barrick Gold and Eugene McBurney of GMP Securities, both shed light on the year’s challenges through a different focus: Jamie on management and Gene on finance.

As the messages at this year’s Forum began to converge, it seemed clear that some of the traditional approaches to the mining business simply aren’t working anymore. Often expressed was the notion that $800/oz. gold looked amazing on the way up, but $1,200/oz. gold at this time is not nearly as positive. The runaway costs of building and operating mines have almost squeezed out profit margins. Lower grades of ore are inflating production costs. Mining companies need to look at the business with fresh eyes, and develop strategies to attract equity capital.

Companies continue to struggle with market valuations and cost control. They are trying to find the right balance between optimizing current operations and preserving their agility to grasp future opportunities. As investors increasingly look at the quality and depth of management as the number one factor in making an investment, CEOs and CFOs are facing tough questions from their shareholders and their boards.

KPMG asked the group of executives in attendance to rank the major risks facing the industry using a brief survey. In the following pages, we comment specifically on the major risks that Forum attendees identified in our survey, and provide insight into how some executives are responding. We have framed the discussion of these key issues in terms of the tough questions management is facing, and should be prepared to answer. By doing so, we hope to support some of the constructive dialogue taking place in the industry as it seeks to reassert itself.

Lee Hodgkinson National Industry Leader Mining Canada KPMG LLP



Major issues facing the mining industryWe asked mining executives how significant do you think the following issues are to the future of the mining industry (a ranking of 5 being the most significant and 1 being the least significant)?

The data returned for this question is as follows:

0% 10%

1

20% 30% 50% 70% 90%40% 60% 80% 100%

Increased Regulation of thecapital markets and Reporting

Ability to raise capital

Controlling capital costs

Controlling operating costs

Access to new projects

Resource nationalization

Environmental regulation

Bribery and corruption

Energy and water supply

Labour shortages

5 18 34 43

16 45 39

2 16 43 39

5 7 30 42 16

7 5 34 43 11

2 509 30 9

4 23 45 23 5

13 50 32 5

2 42 4212 2

27 39 32 2

2 3 4 5


Key Questions for Challenging Times4

Ability to raise capitalMany mining companies are wrestling with contradictory pressures as they pursue capital to operate and expand their businesses. There is reluctance to raise equity capital in prevailing market conditions because any new offering would dilute the holdings of current shareholders. The unwillingness to pursue equity has caused many major and intermediate companies to tap the debt markets, which has leveraged their balance sheets and increased their exposure to interest rate and liquidity risk. Most companies are also trying to generate working capital from within, and are taking a hard look at capital allocation.

Some of the larger companies that had increased dividends in better years are now reassessing. Although they are still committed to returning capital to shareholders, they are also focused on balance sheet strength and judging their ability to protect against so-called “Black Swan” events, all while staying agile enough to grasp opportunities.

The notion of protecting against future shocks bears closer examination. Mining companies need to fully understand the potential impact of macro and micro events that could be caused by sudden, severe change in market conditions, commodity prices, costs, foreign exchange rates, interest rates, production shutdowns, global economic conditions, and/or resource nationalism. A truly damaging Black Swan event could involve a combination of these issues.

That is why better-managed mining companies are running scenario analyses to understand the impact of sudden shocks on future cash flows, bank covenants, and the overall strength of the balance sheet. Using a prudent approach based on robust risk-management practices, they are developing contingency plans to handle a variety of situations that could arise over the coming years, and developing finance strategies to meet a variety of situations.

Key questions about ability to raise capital1. Have you considered sources other than debt or equity, such as strategic investors,

private equity or streaming? If not why not?

2. Have you run appropriate scenario analyses for potential Black Swans?

3. What is your capital allocation policy as it relates to returning capital to shareholders or retaining it in the business?



Controlling capital costsThe frequency and extent of capital cost overruns in the mining industry is well documented. Today, it is not uncommon for companies to delay or even cancel capital projects because costs are spiraling out of control.

Although the reasons for these cost overruns are both complex and intractable, the mining industry must regain the confidence of financial markets by finding ways to deliver on large capital projects. The markets often treat explanations as excuses, and the punishment to the stock price for a cost overrun can be way out of proportion to the scale of the actual transgression. However, companies that succeed in delivering growth projects on time and on budget will impress analysts, cultivate a receptive market, and gain access to financial resources sooner.

What techniques can mining companies use to get a handle on capital costs? It is absolutely essential that companies set up best-in-class project teams that include a broad range of professional skills – not just design, engineering and construction experience. These teams must have the right combined skill set to rigorously manage all aspects of complex capital projects and to oversee the contractors that have been hired for the build.

The old way of conducting these projects – cost plus – is becoming less and less acceptable. Companies need to have the right contractual incentives in place for engineering, procurement and construction management (EPCM).

Companies also need to develop rigorous processes around evaluating capital projects, taking into account the lessons learned over the past decade and be more hard-nosed about knowing when to say no. In times when capital is scarce, not all projects can proceed.

1. Does your upfront assessment process for capital projects stress test all the factors that have led to failure in the past?

2. Have you developed a mega-project threshold that you will not cross?

3. Do your EPCM contracts fairly allocate risk between you and the contractor?

Key questions about controlling capital costs



Controlling operating costsThroughout this century, mining companies have been riding the “super cycle” of higher commodity prices supported by demand from emerging markets. However, most now find that these benefits have been eroded by rampant cost inflation. Virtually every mining company has announced a program of aggressive cost reduction to help widen margins and restore profitability.

The “80/20 rule” has applied to most of these programs; companies have found that exploration expenditures and indirect costs constituted “low-hanging fruit” for cutbacks. To preserve the long-term health of the business, the remaining cuts will require more effort and different ways of thinking about the business.

Realistically, companies must truly understand the nature of their cost inflation if they are going to peel back costs in a sustainable manner. To do this, they must get very granular in the way they view their cost structures, and take a hard look at how much their cost inflation relates to lower-grade ore, price inflation, or loss of productivity.

One gold company commentator at KPMG’s 2013 Mining Executive Forum said, “We mine in tonnes, but we sell in ounces.” Consistent with this logic, many companies are intentionally raising their cutoff grade to ensure a higher level of profitability. Also, now that relatively low global inflation is putting less pressure on prices and labour, the time is right to challenge supplier price increases and to demand higher productivity from the workforce.

1. Do your systems track cost in sufficient detail to identify the key drivers?

2. Have you reviewed major supplier contracts to ensure you are getting the value promised?

3. Do you know how much of your cost increases are due to inflation, grade and productivity?

Key questions about controlling operating costs



Access to new projectsIn the final analysis, mining companies have always made money by extracting and processing ore. The most successful companies have always sought to grow by doing more and more of these activities, and doing it better than the competition.

Now we have entered into an unusual period where growth has almost become a dirty word. For the foreseeable future, access to equity capital depends on placing shareholder value creation ahead of production growth. Nevertheless, the business has not changed so much that companies no longer need a pipeline of growth opportunities for the future.

As part of the overall strategy and planning process, companies need to identify which kinds of opportunities will give them the best chance to succeed. Some of the criteria may include the scale of projects, the ideal jurisdictions relative to existing operations and resource nationalism, and their familiarity with the type of mining and processing of the ore.

Are there good growth opportunities in the industry right now? The interest that private equity is beginning to show in the mining industry suggests that the current adverse climate has opened up a window of opportunity. Companies are well advised to develop carefully thought-out strategies for future growth now, so they can act quickly when their ideal opportunities arise.

1. Is your growth strategy primarily greenfield, brownfield, or acquisition?

2. Do you have the ability to move quickly if the right opportunity arises?

3. What is your investor messaging for the next two years, and when do you start talking investment again?

Key questions about access to new projects



Resource nationalizationResource nationalization is no easy problem for mining companies. In developing countries, it can take the form of expropriation, compulsory co-ownership, or erratic and irrational shifts in legislation and regulation governing taxes, royalties, and licenses. In developed countries (most recently Canada and Australia) resource nationalism usually takes the form of policy changes to raise taxes and/or royalties, or decisions to disallow foreign acquisitions.

Even though resource nationalization is largely out of a mining company’s control, it must still be addressed with a proactive strategy. Just as companies have strategies for managing relations with customers, shareholders and employees, they must also maintain effective strategies for managing relations with governments and communities in locations where they operate.

A major part of this strategy should involve articulating – and creating a clear understanding of – the full economic value of mining projects to the host country. This includes an accurate tally of the company’s total financial contribution in taxes, royalties, duties, wages, infrastructure and other benefits. Especially at a time when production growth is not a priority, jurisdictions should understand that resource nationalism could cause new mines to be cancelled or delayed, or cause producing mines to be shut down, cut back or suspended indefinitely. Financial gain from mining is not an annuity for any jurisdiction; it always requires a partnership approach.

A strategy to counter resource nationalization cannot give a mining company control over every outcome, but building a better understanding of the viewpoints and arguments will help mitigate the risk.

1. Do you know how much you are contributing in total taxes for each project?

2. Do you regularly assess the strength of each government and community relationship?

3. Do you fully map a stakeholder relationship for all of your projects?

Key questions about resource nationalization



Keynote message



After a great run from 2002 to about 2010, the mining industry has been in decline. As with most things, I look at the challenges from a financial point of view.

The biggest challenge for the mining industry is that money has become increasingly scarce. That will almost certainly continue for a while. The financial crisis diverted investor dollars away from the resource sector and commodities into a diversified U.S. market that presented the opportunity for recovery. Many of those sectors, like technology and consumer staples, have indeed delivered for investors. However, the market should never pass on the opportunities that are available when a crisis happens.

On the TSX, mining’s dominant stock exchange, the industry represented over a quarter of all equity financings between 2008 and 2012. So far in 2013, it’s only 10 percent. About 21 percent of listed mining companies have less than C$10M cash on the books, and their options are narrowing.

One option is to attract a buyer or a partner, but M&A activity has also slowed considerably this year. Many of the divestitures are asset-based, which shows that major companies are cleaning up their project portfolios. They are unlikely to consider new assets right now; and at least they feel they can wait, because targets will probably become cheaper with time.

If all of this sounds rather gloomy, let me say that I believe opportunity is born out of crisis. Mining is no stranger to tough times. Larger companies are taking positive steps to cut costs and risk, increase cash flow and win back investors. For juniors, new sources of financing such as private equity seem poised to step in and fill some of the funding gap. Other forms of creative financing will be necessary.

Mining is definitely mired in a down cycle right now, but that will change. In the meantime, we’ll need to carry our umbrellas.

Eugene McBurney Chairman GMP Securities L.P.




12 Key Questions for Challenging Times

Thanks to our Forum Keynote presenters for 2013

Keynote Presenters

Eugene McBurneyChairman, GMP Securities L.P.

Jamie SokalskyPresident and CEOBarrick Gold Corporation


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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2014 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 4781

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