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Geography and geology are not destiny

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World Coal,

Nathan Flesher, Elliot Holland and Eugene Smit, McKinsey & Co., explain why mining companies should not just accept their position on the cost curve.

Faced with the lower coal price environment, most companies exporting into the global seaborne market have shifted focus from all-out production expansion back to controlling cost. Much of this cost containment has come by shuttering unprofitable operations, reworking mine plans to take out higher cost pits and cutting back on maintenance spending and new CAPEX.

These strategies all have their merits, but they assume that the geography and geology of a coal seam are the determinants of the cost to mine it. That is to say, the location of the mine and the quality of the coal product establish overall project costs. This has truth to it: the thinner the seam, the deeper the reserve, the further a mine is from the coast, the bigger the cost challenge.

However, the downturn has proved that the actions companies take also matter. A number of producers in almost every exporting basin are no longer accepting the conventional wisdom that their positions on the industry cost curve are fixed. Instead, they are implementing new strategies to improve their mining operations, in many cases overturning long-standing assumptions about how operations should be conducted in their particular region.

The results are already noteworthy: coal’s era of runaway cost inflation is coming to an end. Costs will inevitably continue to increase, as the highest quality and most accessible resources are used up, but based on the changes starting to be implemented, this is likely to be at a slower rate. Based on McKinsey’s research, we project that nominal cost inflation in Australia, for example, will be only 7%/year from now to 2020, compared with 15%/year from 2006 – 2011. Similarly, in Indonesia, where costs rose at 9%/year from 2006 – 2011, we project only a 5%/year increase to 2020.

Resetting expectations on operations and productivity

What changes are being made? Take the case of Indonesia: the country’s coal industry has traditionally been positioned as low cost and, since the 1990s, it has established itself as the world’s biggest seaborne thermal coal exporter, even though its labour and capital productivity has been lower than number-two exporter, Australia.

Now faced with lower prices, a new generation of managers is resetting expectations on how Indonesian coal mines are run. They benchmark themselves against Australian standards of labour productivity, operating discipline and safety. They do not accept that a shift change in Kalimantan should be any different than a shift change in Kalgoorlie.

Some Indonesian mines now have better labour productivity than some high-wage-country mines. Granted, these best-in-class low-wage-country mines are passing only the weakest performers among high-wage-country mines, but the trend is clear. Consider haul truck utilisation, availability and cycle time – three key drivers of opencast mine labour productivity. Some Indonesian mines study minute-by-minute co-ordination of shift changes to increase utilisation, use in-depth video analysis of common planned maintenance jobs to improve equipment availability, and monitor road conditions with real-time sensors in the truck suspensions to identify problem road sections and decrease cycle times. Such improvement campaigns often increase labour productivity by 10 – 20%.

Taking control of their destiny

Important changes are also under way in Australia. There, the assumption has been that labour, especially contracted labour, is expensive and will grow more expensive every year. But many Australian coal operators are now refusing to accept a lump-sum bill at the end of the month from maintenance contractors with no accountability. Simple controls to ensure every contractor onsite has a clear and approved scope of work, good internal supervision and an auditable record of the work performed have cut half or more out of contract maintenance spend at some mines.

Australian coal operators are also decreasing the amount of labour required. Automated technology has been fully deployable for some time for applications as varied as production drills, haul trucks, road trains and longwall systems, but operators were hesitant to take the plunge and implement it. As prices have fallen and managing costs has become crucial, mining companies now worry about getting left behind. A decisive move toward implementation is now under way.

Producers in other regions of the world are similarly changing established practices. In eastern Europe, for example, producers have long been handicapped by aging, less efficient equipment and lower labour productivity. Now, pushed by lower prices, many companies across the Czech Republic, Poland, Russia and Ukraine are tackling these challenges. In some cases, this requires equipping mines with modern and powerful equipment; in others, operators are improving maintenance practices and operating standards to increase productivity of their existing fleet. McKinsey research shows that equipment availability does not strongly correlate with age: existing equipment can continue to produce. Mines are also establishing new labour agreements, with new shift patterns that make it possible to get continuous use out of equipment. These companies compare their productivity not with their immediate neighbours, but with world-record levels. Some now have cost structures half the level of their unreformed local competitors.

Miners that take control of their own destinies share a focus on operational excellence. Research undertaken worldwide, using McKinsey’s MineLens benchmarking tool, confirms that operational excellence is the ultimate driver of productivity. It also shows that operational performance varies significantly. Moving from average to top-quartile performance can typically translate to a 12 – 25% improvement in throughput and a 10 – 20% reduction in cash costs. The most powerful lever to capture these gains is better equipment utilisation and availability. Higher utilisation can be addressed through initiatives such as tighter production planning, improved workforce performance management and optimisation of equipment dispatch. Equipment availability can be addressed through reliability-analysis programmes, continuous learning from unexpected failures and careful study of maintenance practices.

What do these trends mean for the coal world?

While each major coal basin has structural operating challenges that are difficult to tackle, some miners are discovering solutions. The producers that do not keep pace with these innovations are going to be at the mercy of those that do. Mining companies should not accept conventional wisdom that their positions on the cost curve are fixed. Geography and geology are not destiny.

Written by Nathan Flesher, Elliot Holland and Eugene Smit. Edited by

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