Impact of Production costs on the mining profitability in Australia

Title: Impact of Production costs on the mining profitability in Australia

Executive summary
Mining has been a booming endeavor for the past decade, with it being a major contributor to the
Australian GDP it has made great contribution to the growth of the Economy. In this paper,
factors that influence the profitability of the Australian mining industry are explored and their
relationship determined through use of correlation and forecasting. The results show that the cost
of production has a positive relationship with the industry’s profitability i.e. positive correlation.

Introduction
Overview and problem statement
Accounting for up to 7% national GDP, mining is one of the country’s primary sectors
contributing 50-60% of the total exports made by the country in 2007-2008 (Export Gov, 2018).
Therefore, despite recent economic hurdles in the field, Australian mining still is in shape to
satisfy its market needs given its large mineral resources and hence remains a crucial sector in
the country’s revenue generation (Michael, 2018). Australia’s largest exports include coal i.e. it
is the largest global coal exporter (up to 35% in international market). Other major minerals
include;
i. Lead
ii. Iron ore
iii. Diamond
iv. Zinc
v. Rutile
vi. Zirconium
The country is the second largest exporter of gold and Uranium as well as the third largest
exporter of aluminum.
Mineral exploration
Mineral exploration is largely private. Nevertheless, the government plays a critical role in
identification of minerals through research and other supportive roles. It is such a structure that
may be attributed the importance of profit-cost monitoring since the mining industry players

should always look for ways to sustain themselves in the business and maintain their
profitability.
Costs
The basic mining costs models include: mining equipment costs, smelting costs (hauling and
crashing), mining wages and benefit, taxes, electric power, and supplies.
Problem statement
Just like any other business endeavor, mining is set up for profits, where profits can generally be
viewed as the amount remaining after the total input costs have been subtracted from the total
sales. In this case the input costs will be the operational costs. Predicting the relationship
between operational costs and profitability of mining is therefore crucial to mining companies.
Assumptions of study
Assumptions made in this study are that, the total cost of production in the mining industry is
distributed across all the sub-sectors of the industry. The business environment is perfect, i.e. no
existence of external influence on profitability. Hence, cost of production is the only factor that
affects profitability.
Aim of research
The aim of this research is to explore the impact of operational costs on the mining profitability.
Research questions
In order to achieve our research aim, two questions are formulated:
i. How does production costs relate to profitability in different mining sectors?
ii. Is there a difference in the production costs annually since 1996-2015?

Literature review
Mining and sustainability
There has been a relative positive growth experienced by the mining sector in the past decade
both locally and globally, such a growth has been largely linked to the emergence of China and
India as fast growing economies (Hojem, 2014) given the new demand for minerals in the
international market. In response to the boom there were raised concerns over the industry’s
effect in the short and long term. Australia is strategically located to be able to supply Asia with
the much required minerals and energy products (Satchwell, 2014). In Western Australia, mining
is set to be beneficial a view owed to the large mining deposits in the region. For instance in
2011 WA made mineral exports of USD 13.6 billion which had grown by approximately USD
2.1 billion (Brant, Plevin, and Farrell, 2010) . In 2015 the area exported minerals and mineral
products worth $69.5 billion with those of iron ore being $48 billion (Mayes and Pini, 2014) .
Mining sector since the boom of the 2000s has been able to sustain itself due to the vast and
relatively non-volatile mineral resources boasted by Australia, (Koitsiwe and Adachi, 2015). The
county’s mining sector is a global competitor due to a number of strengths including: its
“resource endowment, view on sovereign risk, access to capital, minimal government
interventions, access to labor, skills and technology ...” (Australian Council of learned
Academies, 2014).
Mining and Australia’s GDP
With its rich deposits of minerals such as oil, iron ore and several others, apart from profits, the
Australian mining industry is a great GDP contributor. For instance, considering oil which is
termed as the “liquid” gold, the only relatively stable price of oil was seen in the 50s and 60s

(Blanchard, and Jordi, 2007) since then, oil prices have been fairly volatile driven by laws of
demand and supply, so has been their effect on the growth domestic product (GDP). Historically,
Carmine (2014) argues that, “Each spike in oil prices is followed by a sharp drop in world GDP
growth.” However, prices are not the only responsible factor in the drop in or rise in profitability
in the mining business. Crowson (2001) notes that, “After keeping roughly in pace with the
world share index for a decade, the index of non-ferrous mining companies' shares fell relatively
in 1997–1998, and has never regained its lost ground.” He attributes such a change to the shift of
interest in investors from the non-ferrous mining sector in favor of sectors such as coal and iron
mining which within that period of time had begun to pick up. In 2010 for instance iron became
the most valuable export in Australia (Gavin and Mohan, 2011).
Revenue, Profit and Cost
RPC is the relationship between the revenue, profit and cost components amongst each other and
the company’s net profit performance (Amy, 2017). In their article on the relationship between
revenue, profitability and cost, Amy (2016) argue that revenue * net profit = profit.
Additionally, the relationship between cost and profit is a direct one such that eliminating a $1
cost increases the profit by $1, hence a 1:1 ratio (Wheaton, 2018). Such costs comprise marginal
costs, variable costs, fixed costs and total costs which can be broadly categorized into implicit
and explicit costs while profits are categorized into accounting, economic, and normal profit,
(Hallock and Hall, 2014), where:
Accounting profits= Total revenue- explicit costs
Economic profits= total revenues- (explicit costs + Implicit costs)