THE ECONOMIC RATIONALE OF ADDING VALUE

by B.R. STEWARDSON

This paper addresses three related issues. First, the extent of mineral processing in Australia at present and the theoretical possibility for further processing; second, the benefits to the Australian economy from value adding: and third, given the present position, why aren’t we doing more?

Graph 1 shows the percentage of mineral output that is processed to refined metal for the major metallic minerals that Australia produces. I emphasise that the graph shows the percentage that is processed right up to the stage of refined metal. It excludes processing to intermediate stages, which are shown in Table 1. Graph 1, for example, excludes processing of bauxite to alumina and only counts bauxite that is processed all the way up to aluminium. Similarly it excludes the processing of nickel ore and concentrate to only matte and oxide and it also excludes the processing of lead to bullion. If these intermediate stages were included (as they are in the table), the lead, nickel and bauxite columns would all go right into the over 75 % bracket.

It can be seen that, particularly if intermediate processing is taken into account, the non-ferrous metals have a fairly high degree of processing already. The minerals where there is a lower degree of processing are by and large those where Australia’s production represents a very large share of the total world production.

Graph 2 shows the value added coefficient for a range of metallic minerals. . The calculations that lie behind this table are set out in Table 2. What is done is to take the relative prices of ore or concentrate and of refined metal. The number of tonnes of ore or concentrate that are needed to make a tonne of refined metal is established. Averages for Australia are used, and actual figures vary substantially from deposit to deposit. The ratio of the prices and the number of tonnes of unprocessed to processed product together give the value added coefficient. That is, if the price of concentrate were $100 per tonne and the price of refined metal were $400 per tonne and if two tonnes of concentrate were needed to make a tonne of refined metal, we would calculate two tonnes at $100 a tonne is $200 for input of concentrate to $400 per tonne for refined metal, so the value added coefficient would be 2.

* Chief Economist, BHP. This paper is based on an address to the Value Added Mineral Processing Conference on 21 March 1991. The author is indebted to Chris Egger for preparation of the tables used in the paper.

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GRAPH 1 MINERAL PROCESSING IN AUSTRALIA. 1989190

Percentage of Mineral Output Processed to Refined Metal Z O 25 50 75 100

Gold

Copper

Lead (a)

. . . . . . . . . . . . . . . .............................. .............................. .............................. ............................. . . . . . . . . . . . . . . . ......................................... ............................................ ...................................... ............................. . . . . . . . . . . . . . . . .............................

.......... . . . . . Manganese (e) 8 .......... . . . . . .......... . . . . . ........ Iron ore .: :.:.:.:.:.:. ....... ....... ....... . . . . . . . .

.. :.

Zircon (0 ... ... ...

Rutile

NOTES: (a) Excludes bullion. @)Excludes oxide and unrcfylcd matte. (c)Includu only bauxite proowscd 10 aluminium. (d)hcnitc pmcuscd mto pigmcnr only (e)M.ng.ncre proceucd to far0 alloy only. (Ozircon (0 procud prodUc1- all forms.

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TABLE 1 MINERAL PROCESSING IN AUSTRALIA. 1989/90

Percentge of mineral output processed [W

Iron Ore

Aluminium Ore to Pig IronlSteel

Bauxite to Alumina Alumina to Aluminium

Ore and Conc. to Refined

Ore and Conc. to Refined

Ore and Conc. to Bullion and Refined Ore and Conc. to Refined only

Ore and Conc. to Matte, Oxide and Refined Ore and Conc. to Refined only

Conc. to Refined

Ore and Conc. to Refined

Conc. to BullionlRefined Conc. to Refined only

Ore to SinterlAlloy Ore to Ferro Alloy only

Rutile to Pigment/Titanium metal Ilmenite to Synthetic RutilelPigment Ilmenite to Pigment only Zircon to Processed Product

Copper

Zinc

Lead

Nickel

Tin

Gold

Silver

Manganese

Mineral Sands

10

69 22

83

36

78 39

1 00 37

5

96

76 34

19 13

0 46 17

5

Principal sources: ABARE: BHP Economics Department.

It can be seen that the value added coefficients are highest in the case of the mineral sands, although also fairly high in the case of aluminium. They are lowest for the non-ferrous metals, the base metals, which ironically is where we do most value adding at present.

Note that there is no connotation of relative profitability in this graph, it is purely the relative value of the unprocessed input to the processed output.

Note also that in the case in particular of copper and lead there is some problem in constructing this index and the numbers that we have should be taken as approximations. The numbers incidentally, are 1.1. One simply indicates there will be no value added at all and so 1.1 indicates just a mere 10% in addition in value. The problem with copper and lead is the gold and silver content of the basic concentrate. However, we believe that the gold

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GRAPH 2 VALUE ADDED BY PROCESSING

Processed Mineral Value Added Coefficient (a) 1989190

0 5 10 15 20 25

Zirconia

Titanium pigment (llmenitt)

Aluminium

Titanium Metal (Rutile)

Elecmlytic Manganese Dioxide

Steel (billet)

Pig Iron

Alumina

Synthetic Rutile

Ferrornanganese

Zinc refined

Nickel refined

CopperlLeMin refined

Note (a) The factor by which the value of unprocessed mineral consumed is increased by processing to the stage indicated.

and silver content of the copper concentrate only accounts for on average about 5% of its value. There is a further problem in the case of copper, in that copper concentrates were in short supply in 1989/90, which somewhat abnormally boosted their price relative to the price of refined metal.

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TABLE 2 RELATIVE PRICES AND TECHNICAL CHARACTERISTICS OF MINERAL PROCESSING, 1989190

Relative prices Primary input Value added $A /tonne coefficient (a) coefficient [b)

(Average job export prices j

Iron and Steel Iron Ore (fines] Pig Iron Steel (billet) Aluminium Bauxite Alumina Aluminium Copper Concentrate Refined Zinc Concentrate Refined h o d Concentrate Bullion Refined Nickel Concentrate Matte Refined Tin

22 160 300

30(c) 330

2290

980 3400

600 2210

540 1150 1070

NA 7300(c)

12550 (c)

1.5 1.8(e)

3.0 6.0

3.3

1.9

1.8 1.8

4.8 7.6

3.7 12.7

1.1

1.9

1.2(f) 1.1

Concentrate 4780 Refined 10530 2.0 1.1 Manganese Ore 154(c) Ferromanganese 680(c) 1.7 2.6 Electrolytic Manganese

Dioxide 1920 (d) 1.5 8.3 Mineral Sands Rutile 700 Titanium Pigment 2 700 1.1 3.5 Titanium Metal 13500 (d) 2.0 9.6 Ilmenite 75 Synthetic Rutile 480 1.8 3.6 Titanium Pigment 2700 2.0 18.0 Zircon 660 Zirconia (90% Zr 0 2 ) 22500 (d) 1.7 20.0

Notes: (a) Primary Input Coefficient

Tonnes of unprocessed mineral input required to produce a tonne of semi-processed or processed output.

The factor by which the value of unprocessed mineral consumed is increased by processing to the stage indicated (Value Added Coefficient equals gross sales value per tonne divided by the value of unprocessed mineral input consumed).

(b) Value Added Coefficient

(c) Indicative export prices estimated by BHP Economics Department.

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TABLE 2 continued

(d) Indicative world market prices estimated by BHP Economics Department. (0) Assumes 100% pig iron charge to the blast furnace, i.e. no scrap component. (f) Includes silver credits. (g] Coefficient based on tomes of matte required to produce a tonne of refined nickel.

However, the graph gives at least a broad indication of the value added coefficient for these metals.

The third graph shows the export receipts that would theoretically be possible if all the metallic minerals that are currently not fully processed were to be all fully processed. Note the emphasis on theoretically possible export receipts: that point will be elaborated on shortly. If all metallic minerals were fully processed to refined metal stage, Australia could earn an additional $27 billion per annum in export revenues.

Although as was seen from the previous graph, the greatest value added coefficients were in the mineral sands, in fact because of their quantities they would account for only around 10% of this total increase. Much the largest component of this theoretical increase would come from steel and aluminium, because of the abundant quantities of iron ore and bauxite we produce.

However, this is very much a theoretical concept and it is certainly not being put forward as a practical possibility. Consider the following figures.

In the case of steel, last year we exported about one million tonnes, and incidentally BHP Steel is increasing its steel exports this year to two million tonnes, and this would be on an ongoing basis. The theoretical extra export receipts from processing all of our vast quantity of iron ore production into steel would mean that we would increase our steel exports by 54 million tonnes. Btal world steel trade at present is only 170 million tonnes. In other words we would be talking about gaining a third share of the entire world trade in steel. Another way of looking at it is to say that the theortical extra production of 54 million tonnes can be compared with total western world production of finished steel output, which is 425 million tonnes, so that would be 13 % of it. Again this can be compared with the world’s largest producer of steel, Nippon Steel. It produces 28 million tonnes, so we would therefore be talking about producing for the export market an amount about equal to another two of the world’s largest steel producer.

In the case of aluminium, Australia currently exports about 900,000 tonnes per annum. The theoretical extra involved in processing all our bauxite to aluminium would involve another five million tonnes of aluminium. At present world aluminium trade in total is 7.3 million tomes, so our theoretical construct would be assuming that Australia could produce 81% of the world total trade. Another way of looking at it is that we would be producing 43% of current western world aluminium output, or more than the entire output of the world’s largest producing country, namely the United States.

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GRAPH 3 THEORETICAL EXPORT RECEIPTS FROM MINERAL PROCESSING

Steel

Aluminium

Gold

Titanium

Manganese

Nickel

Z i o n

Lead

Silver

Tin

1989/90 Actual export receipts from ore, concentrate and metal Export rcceipts if all minerals 0 w e n processed

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Similar examples could be given for some of the other minerals and metals whose total values amount to smaller figures. For example, as can be seen from Table 3, the figures assume that Australia can expand to a maximum equivalent of 100% of existing western world output in production of electrolytic manganese dioxide, titanium metal, and zirconia.

TABLE 3 THEORETICAL EXPORT RETURNS FROM MINERAL PROCESSING

Actual value of selected mineral and Theoretical export value if all minerals

$Am $Am metal exports 1989/90 were processed

Iron Orelsteel 2340 Steel 16530 BauxitelAluminalAluminium 4943 Aluminium 13802 Copper 666 Copper-refined 685 Zinc 1164 Zinc-refined 1764 Lead 44 7 Lead-refined 441 (a) Nickel 755 Nickel-refined 791 Tin 81 Tin-refined 89 Gold 2875 Gold-refined 2995 Silver 7 Silver-refined 183

289 Electrolytic Manganese Dixoide 288 (b) 580

Manganese

Titanium concentrate 309 Titanium metal 655(b) Titanium pigment 286 Titanium pigment 2308 Zircon concentrate 270 Zirconia and other zircon

TOTAL OF THE ABOVE 14432 41811 Total Mineral Resource

Exports 24505 51884 Total Merchandise Exports 47785 75164

Notes: (a) Net fall due to loss of silver credits from former lead bullion output.

Ferromanganese

products 700(b)

(b) Assumes Australia can expand output to a maximum equivalent of 100% of western world output.

Clearly these and the figures given for steel and aluminium are unrealistic to say the least. The theoretical possibilities and their unrealism are presented to illustrate the need for considerable caution when interpreting and giving weight to the claims that we get for further mineral processing in Australia. This is not to deny that some further processing may be possible, but there are clear limits to some of the numbers that are from time to time bandied about in public.

The second section of the paper looks at the benefits to Australia from increased processing of minerals. The major benefit to the Australian economy from further value adding is that it would be of major assistance to the balance of payments. The value added metals would either be exported directly (as seems most likely) or used to produce manufactured goods which in turn would be for export or import replacement.

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It is emphasised at this point that the paper is limited to discussing value adding to the stage of refined metal. There is no reason why processing in Australia should necessarily stop there. It can go on to more highly processed versions of the basic metal produced (as, for example, BHF’ Steel is doing with its coated steels for export) or it can go further and use the refined metal as an input in manufacturing a finished product. Supply of the basic refined metal is obviously a prerequisite for those later processes, and domestic production of it makes it more probable that the further value adding might take place in Australia.

Australia’s current economic deficit is very substantial and it, together with the accumulated level of overseas debt, is a major constraint on the Australian economy. Any increase to export revenue and thereby reduction of the current account deficit would be extremely useful.

To put the numbers in perspective, in 1989190 Australia’s current account deficit was $21 billion. It has already been emphasised that the $27 billion extra revenue resulting if all our metallic minerals were fully processed into refined metal is an interesting theoretical number but a totally impractical one. Nonetheless, it illustrates that even a small part of it would make a significant contribution to our current account deficit.

A second benefit from further value adding is the spin-offs involved in terms of technology. Value adding plants may well involve a considerable amount of research and development expenditure in order to adapt a known process to the particular quality of Australian ores and the knowledge acquired may well have wider application in the community. This is of particular importance at a time when Australia is losing much of its engineering base.

A third benefit may involve employment generated by the value adding plant, but the extent to which this is a net benefit depends very much on what alternative economic activity if any would have taken place in Australia in the absence of the construction of such a plant.

The third section of the paper may now be addressed. If there is so much theoretical potential for further value adding in Australia and if it would be of such value to the economy, why is Australia not doing more of it now?

The immediate answer to that, but one which is often overlooked, is that industry will only undertake value adding if it is profitable for it to do so. That more value adding is not undertaken in Australia must therefore mean either that all Australian businessmen, and indeed all international businessmen who know of Australia, do not recognise a profitable opportunity when they see one, or that such operations are not sufficiently profitable to justify investment. The other side of the same coin, that is the national interest side, is that we should only want investment in these projects if they represent the best allocation of resources. If they do not represent the best opportunities for private profit, then, unless there is a significant diversion of private and social returns, the projects also do not represent the best allocation of resources for the country and we should not bemoan missing them.

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We need to look a little deeper, however, to see why value adding in the minerals industry in Australia may not be a profitable opportunity for business at the present time.

This may be considered under two headings. One is reasons applying to all mining countries and the other reasons applying peculiarly to Australia.

Let us look first then at the reasons applying to all mining countries. There are two basic reasons to consider in this category. One is location and the other is market structure.

First then, location. There are a number of reasons why it is not necessarily advantageous to process a mineral in the country in which the ore deposit is located.

One reason is that it may be cheaper to transport material from the mine to the market in the form of bulk ore or concentrate than it is to transport it in the form of refined metal. Bulk carriers and bulk handling techniques at ports have resulted in a situation where it is often cheaper to transport the material in unprocessed form than in processed form, even allowing for the fact that one may need more tonnes of unprocessed product to produce one tonne of metal eventually.

This picture may be affected by whether the mine is located near the coast and accessible to a deepwater port or whether it is located inland. However, even in the case of inland mines, bulk transport methods may still allow the larger quantity of unprocessed material to be transported economically.

The second reason why it is not necessarily advantageous to process ore into metal in the country where the mine is located is that there are advantages in processing as close as possible to the market, so as to be able to respond more flexibly and quickly to varying demand and in particular to varying product specifications of customers.

The third reason is that the economics of smelting and refining are often importantly dependent on the ability of the processor to sell by-products produced. For example, sulphuric acid in the case of smelting copper. The availability of markets for such by-products may be much greater closer to industrial centres than it is in a remote mine area.

Fourthly, the cost of processing may be greater at the mine than at the market, if the mine is located in a remote area as is frequently the case. In such instances infrastructure has to be specifically provided and the cost of bringing all factors of production to a remote area will probably be greater than that of providing them at an area closer to an industrial market. The alternative of processing in an industrial centre in the mining country may simply involve a double cost of transport, from remote mine to industrial centre and then on the overseas market.

For those four reasons, it does not necessarily make economic sense to process the mineral in the country where the ore is mined.

The second reason applying to all mining countries why value adding may not be a profitable option is that of market structure. There is a very considerable difference between setting up a refinery when there is a shortage of refinery capacity in the world and a new refinery is needed,

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and entering an industry when there is already excess capacity and you have to compete against existing plant, much of which may already have written off its initial capital expenditure.

In many metal industries today there is still some excess capacity. The degree of excess capacity and the rate of growth of demand, both expressed in relation to the minimum economic size of a new refining plant, determine for each metal how soon opportunities for new plants arise. An alternative way of expressing the same thing is that they determine how soon the need for a new plant arises.

This raises the question of whether smelting and refining is an attractive profitable activity in its own right or whether mining companies only undertake it if it is necessary in order to provide a market outlet for their product, that is if they need to process it in order to be able to sell it at all.

In theory, one would expect the exploration and mining sector of the industry to show a higher rate of profit than the smelting and refining sector, because the exploration and mining sector is the more risky and requires a higher return to compensate for the extra risk. It is true that the smelting and refining sector usually involves a very large amount of capital and carries the risk of new technology rendering its plants out of date. None- theless, processing carries less risk in the sense that it is basically taking a known product, putting it through a known process and taking a profit for this relatively less risky service, whereas the exploration and mining sector of the industry involves searching for mineral deposits which may never be found at all.

It is very difficult to get an adequate series of profit figures to illustrate this point, because so many major companies span both sections of the industry. However, one source has been the Australian Mining Industry Council’s Mineral Industry Survey, which gives a breakdown of profit rates for the industry by exploration and mining on the one hand and smelting and refining on the other. These figures are shown in Graph 4. They show over a 14 year period that the returns to the exploration and mining sector of the industry have been greater than those to the smelting and refining sector, except in the case of four years. Those four years are 1980/81 and the latest three years.

The reason for those exceptions is that in this split between exploration and mining on the one hand and smelting and refining on the other, we are also getting involved in the split between ferrous raw materials and non- ferrous metals. The smelting and refining sector in the AMIC survey is almost wholly the non-ferrous smelting and refining industry, because iron and steelmaking are excluded from this particular survey. On the other hand, the exploration and mining sector of the industry are heavily dominated by energy and ferrous raw materials, iron ore and coal, because of their substantial volume of operations. In the last three years covered by the graph the prices of non-ferrous metals were quite high, whereas the ferrous raw materials did not enjoy a similar price rise other than perhaps in the last year of that period. Much of the higher non-ferrous prices has rubbed off

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onto the smelting and refining sector, and therefore these three years, while apparently an exception to the rule that smelting and refining is less profitable than the mining sector, are really being confused by a split between more profitable non-ferrous metal prices and less profitable ferrous mineral prices during that period. This explanation of the exception may well generate scepticism about using this series of figures at all. However, it is the best series that can be offered and it is put forward as being at least indicative of comparative profitability.

GRAPH 4

[Exploration and Mining versus Smelting and Refining-Australia] EFFECTIVE AFTER-TAX RETURN ON YEAR-END FUNDS EMPLOYED

5% 25

4 Smelting and Refining

76/77 78/79 80/81 82/83 84/85 86/87 eS/m Source: AMIC Minerals Industry Survey 1990.

One cannot generalise too much on this point, and all we can really conclude is that the profitability of the different sections of the industry varies from time to time and from product to product. It remains true, however, that one faces a very different situation establishing a new processing plant in a situation of surplus capacity to one of shortage.

For example, in recent decades the Japanese have almost totally closed down their aluminium smelters because of high power costs, and 'this may partly explain why the Australian bauxite producers have gone downstream to producing alumina and smelting it into aluminium to the extent that they have. On the other hand the Japanese in particular, and to some extent the Europeans, still operate copper smelters and refineries without their own domestic mines and therefore represent a market for copper concentrates, which again may partly explain why newly opened copper mines around the world have chosen to sell their product as concentrate rather than refining it into metal.

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So those two reasons, location and market structure, are both reasons, applying to all mining countries and not just Australia, why value adding in the mining country may not necessarily provide a profitable opportunity. The other two reasons relate specifically to Australia.

One of them is the well known costs of operating in Australia. There are three main areas of cost. One is the cost of capital, which is largely a reflection of high relative interest rates and partly a reflection of poor depreciation provisions for tax purposes. Another is the high cost of labour per unit of output, which is largely a reflection of wage rates. The third is the high cost and inefficiency of infrastructure in the broad sense of the word, that is the government provision of transport, port and waterfront facilities. Until all these factors are tackled, Australian mineral processing, and indeed all manufacturing industry, will remain disadvantaged compared with the rest of the world and this will continue to deter business from setting up in Australia.

The final reason, which again relates to Australia, is the lack of a body of technological expertise. This is not a matter of lack of facilities for education, nor is it to deny that Australia has some leading skills in the area of mineral engineering, but simply that there is some minimum critical mass of industries involving technology which is required to justify and bring forth the existence of a substantial engineering support industry. Australia’s basic engineering industry and its capacity to construct mineral processing plants is withering and its high technology support industry is not substantial. Thus, new mineral processing ventures, if they require high technology support, are very much on their own, whereas in Europe, Japan and America such backup is readily available.

To sum up, there is substantial potential for adding more value to our minerals by further processing them in Australia. Such added value would be of great benefit to Australia and the possibilities should be examined carefully. However, it would be a gross over-simplification to say that merely because we have mineral deposits we necessarily should process them in Australia. Some of the current reasons for not doing so are within our own hands to reform, and it is to be hoped that the micro-economic reform program will be greatly accelerated. But even if everything required on that front is done, we should not automatically assume that we should process everything in Australia. The major factors determining the location and timing of new processing plants have been spelt out. What stands out clearly is that each case needs to be considered on its own merits. If there is one generalisation that can be made from this paper, it is that on the issue of value adding you can’t generalise.

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