What do we do when the mines stop?

South Africa's gold mines are old and there doesn't seem to be a successor on the horizon

Johannesburg - 

Much of South Africa's history, and its sense of itself as a nation, rest on our gold mining industry. For decades, South Africa was the world's largest gold producer, our biggest city - Johannesburg - is the product of our gold mines, and many of our biggest companies were born in the gold fields.

Thus it's hard for us to accept the fading of our gold industry, even though the evidence of its demise is incontrovertible. The problem, in a nutshell, is that we have mined out most of the country's safely and cheaply accessible gold. There's plenty of gold left in the ground, but it's buried too deeply to be mined safely and economically within the context of South Africa's laws, cost structures and regulations.

The story of South Africa's declining gold industry is told by the chart below, which shows South Africa's declining contribution to global gold production (the chart below that shows total global production for comparison purposes).

There are a number of factors influencing the decline in our gold industry, including issues of mine safety, rising costs, and the nature of South Africa's gold deposits.

Mine safety and SA gold deposits

In South Africa, mine safety is a major flashpoint among mineworkers, government and mining companies. Many areas of the country have been continuously mined for decades, meaning that most of the easy-to-access gold has been dug up and miners must go ever deeper to get to the yellow metal. South African mines are the deepest in the world, and the risk of accidents increases with the depth of the mines.

Mine accidents and deaths are not inevitable on deep shafts. In fact, research suggests that the majority of accidents in South Africa's mines are caused by a failure, by mine workers and management, to adhere to safety procedures. But whatever the causes, South African mines have a relatively high fatality rate compared to mines in the United States, Canada and Australia, although our safety record is much better than those of mines in places like China.

When evaluating mining projects, local mining companies must decide whether or not a shaft can be mined safely, and whether safe mining of the shaft would be prohibitively expensive. Safety and cost concerns have led to many mine shafts being shuttered, leaving the millions of ounces of gold in them untouched.

Rising costs

Due to various pressures, costs on local mines have been edging upwards for years.

Wage costs have been rising fast for several years, and continue to do so. Currently, there is a dispute over wages between South African gold mining companies and various trade unions, which may lead to a strike. Mineworkers are demanding a 15% wage increase, while employers are offering 8 to 10%; both the demand and offer are higher than the official inflation rate of 8%, and will only add to the already steep costs of mining South African gold.

Other costs have also increased, particularly electricity. Since January last year, Eskom's tariffs have leapt upwards. In June last year, Eskom was granted a 27% tariff increase, and in June this year, the utility got an extra 31.3% increase. The National Energy Regulator of South Africa also said that South Africans could expect another three years of 20 to 25% increases.

Rising electricity costs are a burden on local mines, and constrain their capacity to grow and increase production.

Gold prices and the rand

Another challenge facing local mines has to do with the way that mine costs and income are structured.

Basically, the gold price is set internationally and is denominated in dollars. Although we see the gold price changing on a moment-by-moment basis on the markets, some mines enter contracts to sell particular volumes at certain prices, although this is becoming less common. Either way, local mines are price takers - the price of gold is set outside their control and they must accept what they can get.

On the flip side, local mines costs are denominated in rands. They pay their workers in rands, they pay Eskom in rands, and so on. Therefore, they are exposed to currency risk. If the rand is weak against the dollar they do well, when the rand strengthens they struggle.

By way of explanation, imagine the gold price is $100 per ounce. If the rand is at R10 to the dollar, then local mines receive R1 000 per ounce of gold. If their costs are, say, R500 an ounce, they do well. However, let's say the rand strengthens to R5 to the dollar, then they would just be breaking even, earning R500 an ounce and spending that all on their costs.

The volatile currency makes it difficult for local mines to plan effectively, and makes them hesitant to invest in increased capacity.

There are other issues in South Africa, including a burdensome regulatory regime that has also depressed investment. All these factors - some the unavoidable consequences of geological reality, others created by inefficiencies in the local economy and regulatory regime - have combined to erode the once-mighty South African gold industry.

The question that remains is what we will develop to replace gold mines as our primary engine of growth? One candidate is platinum mining, but many of the problems that beset gold mines are also problems for the platinum mines. Unfortunately, there is a shortage of other candidates, but South Africa will need to find something to inspire and power our economy.

This story was first published on Discovery Invest

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