Resource strategy & scenario modelling

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Published: Monday, 23 April 2012

‘Resource strategy’ entails more than simply mining and selling products; it encompasses issues such as capacity planning, expansion timing, and political mindset, as Jeff Loehr explains

More than one mining executive has questioned me directly on the importance of strategy in the resources industry. ‘Rocks in the box’ is how one executive explained their company«s approach: we dig a hole and we move tonnes. We produce and that is our strategy.

But strategy does matter. Strategy is about setting the direction for the company and deciding up front many rocks we really need given their potential worth. Ensuring access to the rocks depends on the local political environment and the cost of extraction, and logistics depend on how well a company manages all of the external and internal variables affecting its value chain.

In fact, we regularly see four critical strategic issues that all resources companies must consider: access to resources; decisions on building, acquiring or otherwise expanding production; where on the value chain to operate; and the price to charge for product.

There are myriad other company and industry-specific issues that must be drawn out, but these are always present and are a good starting point for strategic discussion. This article explores these strategic elements and their importance.

The strategic discussion must also lead to an actionable strategy addressing these and other company specific dimensions. The commonly accepted approach is apparently a 200-slide PowerPoint pack summarised with five point plans and strategic pillars: “We will invest in top tier assets”, or “Create value through a focus on cost control” tend to constitute strategic initiatives, while the printed slide deck is an excellent desktop tombstone of the work done to develop these.

While strategic pillars are fine and useful communication tools, a strategy must be more than that. Strategy must be a plan of action. Of course we also know that no plan survives first-contact with the enemy, and in this case the ‘enemy’ is a very unpredictable real life. So a strategy should not just be a rigid document or an unassailable plan, but rather a way of thinking that helps management weave through the changing landscape and make quality decisions that add value to their businesses.

We use scenario planning to help executives think through their options as well as guide decision-making in the future. The second half of this article will describe that process and the tools we use to create useful strategies.



Lithium Americas’ Cauchari-Olaroz brine project, Argentina. The company has an agreement
in place with the aboriginal community to develop the local resources.


Key strategic issues: access to resources

The first of the four main issues is ensuring access to the resources that a company mines. The challenge varies substantially by legal jurisdiction, is made more complicated by working in multiple jurisdictions and regardless of where a company is operating it is always present. The challenge itself can also vary considerably ranging from true permission to mine to permission to export to just permission to keep stock on the ground.

We faced an extreme example in Africa: one client had thousands of artisanal miners digging with spades and pick axes into their ore body to mine and sell small quantities of ore. Creating a safe, efficient mine meant removing the artisanal miners and bringing in trucks. The company involved faced convincing the government to grant mining licenses while keeping the people calm, engaged and, in the end, fed until the long-term substantial benefits began to surface. This was only achieved with a clear, flexile strategy and consistent, continuous messaging.

These issues are not unique to Africa; a Canadian ignores First Nation concerns at his or her peril, and everybody is very happy with economic development as long as it is “not in my backyard”. Regulators, environmental groups and concerned citizens may substitute for artisanal miners, but the challenges exist everywhere.

A flexible strategy for managing stakeholders must help to ensure access to resources. The strategy should address who the relevant people and institutions are and provide an integrated approach at working with these stakeholders. But it also must be flexible enough to allow for unpredictable responses or changing situations.





Building, acquiring & expanding

At issue here is the cost and value of expanding - either current production or into new markets. This necessitates thinking about long-term price trends, but also managing risk and considering market effects.

Thinking about price is an important part of strategy. But instead of focusing only on straight-line price predictions, the strategy also needs to consider a company«s options. Looking at various price scenarios and creating options to deal with each is a valuable exercise for increasing value and decreasing risk.

There may be options to stage investment in order to avoid spending too much at one time or too early. Even building too much capacity may be a good way to discourage others from investing while keeping control of the excess capacity in the market.

New markets and new technology can drive disproportionate returns but also require careful assessment. The potential of technology is often undervalued while the promise of new markets is often overvalued.

Many concerns come in to play in increasing production, and the critical strategic question is how to manage these investments over time; avoiding exposure while maximising the opportunity. Any company strategy should provide guidelines for thinking through these decisions.

Value chain considerations

While a lot of time is dedicated to predicting future prices, often little time is spent thinking through the value chain. Yet examples of value chain issues are everywhere. Alcoa and Alcan (now Rio Tinto) strategically invested heavily in the value chain even to the extent that Alcan was (is) one of the world’s largest hydro-electricity generators.

Alcan owned everything from bauxite mines to packaging materials because that is where the company saw the value in the aluminium market. Rio Tinto, after the acquisition of Alcan, has a different strategy and has sold off the packaging arm to focus more on aluminium production. This is one aspect of value chain strategy.

Value chain considerations should also include logistics to the customer. An operator of a landlocked potash mine counting on sea-borne sales needs to carefully consider how it will move material from the mine to the port and who is going to extract what value along the way.

The US is famous for railroads with monopoly power that are able to extract nearly all of the value from landlocked operations. Not considering these issues up front allows other players in the chain to extract a disproportionate share of the value.

Deciding where and how to participate in the value chain is an important strategic decision. It is also a topic that must be managed over time to avoid being held hostage by other parties.





Price

Price is almost always a challenging concept. Many industrial minerals companies tend to discount the importance of price thinking. But industrial mineral markets in particular tend to face opportunities where ignoring price can lead to leaving large amounts of money on the table.

In one instance, we worked with a company selling a chemical-type product into an industrial market. Our client knew that they were selling at a higher price than the competition yet customers would continue to buy from our client, even while continuing to purchase from the competition. This baffled the management team until they realised that customers were purchasing reliability - our client’s reliability ensured that their customers never ran out of product even when the competition could not deliver.

Such a situation can have a huge effect on pricing policy. Our client was able to increase prices and sell value-adding logistics services. They settled for lower tonnage but at a higher margin and with reduced production costs. This can also lead to developing specialised products and pricing them according to the value added rather than any sort of external price.

Strategy should not just be about predicting future prices but also about understanding how to manage price. It should serve as a guide in identifying opportunities to push prices up as well as accepting situations where lower prices are acceptable.

Using scenarios for strategy

These strategic issues do not represent an exhaustive list, but in our experience these are the common elements that almost always play a role. The critical point is to identify these issues and develop a strategic plan that addresses these issues.

Of course today«s world changes far too quickly for a rigidly set out plan, so management teams need a flexible approach to strategy. They need to think through how their environment can change and how well positioned they will be to act as it does change. And this is where scenario planning comes in to play.

Scenario planning is not a process of predicting the future though it does involve a great deal of future thinking. Scenarios impart a dynamic element to strategy, one that gives companies insight into a number of different future directions that their market may take and how they want to manage in each market. It is the dynamic element rather than the future predictions that make scenarios valuable.

The process of creating scenarios is straightforward; the trick is to ensure a lot of conversation and robust debate at the highest levels in the company. Often this can involve external participants who bring new and different perspectives to the discussion and external facilitators who ask questions and push in directions that internal participants would not. The debate and discussions can be as important as the final scenario product itself, both in surfacing ideas and concerns as well as ensuring that everyone is working from the same base.

The first step in the process is to identify the narrative of the business - creating one truth for the management team. This is often more difficult that it sounds with different executives having views ranging anything from slightly to structurally different views of the market - and a company’s place in this market. But a common understanding of a company’s position in the market and the issues it faces is critical to developing meaningful scenarios.

A good place to start with this one truth exercise is to ask questions around the four main issues above. What concerns does the management team have around gaining or retaining access to resource? What are the price trends, what is the market balance and what are current expectations?

Once this narrative has been established, the next step is to brainstorm and capture major trends and uncertainties in the market - what is happening now in the market and how is this likely to continue?

A trend may be something like an increasing or decreasing dependence on a product, a move towards substitution or a drive towards efficiency. Trends will tend to have an observable time component. Uncertainties are question marks facing the company, such as whether a carbon tax will come in to effect or a jurisdiction will grant the necessary permits.

Trends and uncertainties are related: a trend towards more environmental awareness could lead to a decision on the uncertainty of a carbon tax, for example.

The next step is to cluster and rephrase the trends into higher order or more relevant topics. A number of crazy ideas will come from the brainstorming and some of these will be irrelevant, but some can be brought together within a broader concept.

Usually important themes will emerge in this conversation and the team can easily pick two to become the axes of the scenario set. Other important trends and uncertainties can serve as wildcards or events to build into the scenario stories later.

Plotting the trends as axes on a Cartesian plane helps provide a visual reference, with each quadrant a scenario.

Considering scenarios for energy, for example, could lead to a Y axis on global stability and an X axis on the trade-off between nuclear energy and renewables. The quadrants of the Cartesian plane give us the potential scenarios such as the first quadrant where nuclear energy wins out over renewables in a stable world.

Four scenarios can feel a bit limiting, but is enough to create a variety of outcomes and create the dynamism we are looking for. Adding more scenarios makes working them unwieldy with little additional benefit, but the four scenarios must also be different enough to create very different actions.

What if solar continues to become rapidly more efficient and less costly? What would a new nuclear reactor type do? How would nuclear meltdown (like in Fukushima, Japan) affect the scenarios? All of these should feature in the scenario stories and in thinking through how the scenarios will develop.

Creating scenario stories

An important part of scenario creation is to create vivid scenario stories and descriptive names that participants can relate to and use for strategic planning. All of the uncertainties and wildcards come in to create the scenario stories and they will be resolved in different ways within each scenario.

The storytelling itself is an important step in moving from abstract ideas on a white board to a world that people can effectively imagine. Once the management team can put themselves in to the scenario they can start to think about how the business would change and how they would manage it differently.

In this case the ‘Nuclear Wins’ scenario would be the most attractive for businesses involved with nuclear energy generation, but the fragmentation issue will lead to very different market conditions.

Nuclear Renaissance would see more, large centres of power generation, well controlled by international regulators.

Energy Inequality would be a more distributed approach with perhaps containerised nuclear reactors, or smaller installations focused on local needs.

The Solar Belt would be an opportunity for renewable energy companies and their suppliers. Global stability in this case could mean a solar belt around the equator, capable of even providing base load power to the globe, around the clock. Whether or not such a belt is the actual manifestation of stability (or even feasible) is irrelevant, the key theme is cooperation and green energy.

Finally, Energy for the Village implies a fragmented world perhaps with pockets of strong nuclear demand especially for base load generation, but also a strong renewables component, which keeps nuclear growth in check. These could each represent different opportunities for different players.

These scenarios need to be more than a point in time or a one-line observation. To be useful the scenario stories need to develop over time and present a view of how the world could develop over the next five to twenty years - with all of its twists and turns that such a long term implies. Incorporating Black Swans and scenario economics allows us to capture these changes.

Black swans and scenario economics

Individual black swans may be rare, but their impact on global markets is continuous. From storms to discoveries, technological marvels to disasters, black swans drive change. So scenarios need to consider the effect of these random events.

Once the scenario stories are sketched out, the team should think about what random events could occur to change things dramatically. These could be wildcards identified earlier in the process or wars, discovery of substitutes, or even the collapse of the economy.

During the height of the most recent boom we included economic collapse as a black swan in some of our scenarios. We didn’t know when or how this would happen, but we knew something along those lines was possible so there was value in thinking about how this would affect the scenarios and what direction a company would take if it were to happen.

Today a Chinese slowdown is always in our commodity scenarios. China may not have a major slowdown, but on the other hand no economy has ever continued to grow at over 10% indefinitely - so a change in direction is worth thinking about.

We also create an economic story around the scenarios and the black swans. To do this think about the impact of events on economic drivers important to your business; how would exchange rate change? Or price? Or logistics cost?

The end product is a series of scenarios with meaningful economic drivers. The management team can then think about the options available to them and how these will change within each of the scenarios. The options can be valued based on the economics and the management team can develop different approaches and risk mitigations that would apply within each of the scenarios.

Creating a dynamic strategy

The scenarios and scenario stories are the first step in the strategy process. Once these are created the team considers its options and how they fare within each scenario. Doing this helps identify the major risks and conditions for success and allows the team to both plot the strategic direction for the company as well as start to consider tactics for getting it there.

The scenarios will be as inaccurate about the future as any other prediction. But the value comes from thinking through the various economic drivers, how they play out and where a company wants to be. Regardless of what happens management will be more prepared to confront future challenges.

As time goes on and the future develops the team should track the development of reality and match it to scenario signposts to assess whether the market is moving in one direction or the other. As they see developments, managers can think about what actions to take, what effect their actions will have on other players and where that will potentially lead.

Conclusions

Resource companies can often get by with ‘rocks in the box’ strategies for a time. As long as a team keeps producing and there is a buyer on the other side of the equation many companies can stay afloat. But without a useful strategy that can act as a constant guide in decision-making, a company will end up with lower returns and potentially even lose its ability to operate.

Scenario planning is one way to creatively think through the strategic challenges that any company faces. The value of scenario planning is in the flexible strategies it supports and the creative thinking it requires. Scenario planning can lead to a 200 page slide deck, but rather than a desktop tombstone these slides become a reference manual for setting a company’s direction and keeping it successful despite the twists and turns of reality.

Contributor:
Jeff Loehr, managing director Americas, Virtual Consulting International, a leading resources strategy consulting firm. Loehr joined VCI from a leading global mining company where he headed business development efforts for the company and acted as a transaction/investment advisor.