Captive mines are very popular in South Africa with large-scale commodity buyers, often former or current parastatals such as Mittal (formerly Iscor) and Eskom. The contract is usually constructed around a cost-plus basis where the buyer pays for the entire mine’s operating cost and capital expenditure, plus a percentage ‘management fee’. On the face of it, this option creates a cheap source of commodity and significant control over the operations, as the buyer approves the budget of the seller and hopes to control input costs. The buyer also gains control over the entire output of the mine by prohibiting sales of product to any third parties. This way the buyer uses the captive mines as a baseline load for input resources and tries to only buy on the open market to accommodate for variability in demand.

The truth is somewhat more complicated. The inherent logic of captive mine deals is that you build in inefficiency, as the mine makes more money by adding costs. As the mine has an informational advantage over the buyer, most buyers are not really in a position to challenge the cost escalations of a mine. The result is that the mine operates with very large pyramidal structures, often with a mindset of a bygone era of employer for life / employment creation for the white poor phenomenon of the Great Depression.

If costs escalate beyond acceptable levels, the mine may be closed, but it is very unlikely that such mines will ever really operate at competitive levels or cost efficiently if compared to similar commercial mines.

Even more confusing is the question of assets, where the buyer effectively owns the assets (the principal), but they are operated by a mine (the agent) who has no interest in extracting a proper economic return out of the assets, but to ease the workload. Over-capitalisation or inappropriate capitalisation is typical of such mines. Again, the seller has an informational advantage that makes it easier to justify capital.

Somewhat contradictorily, Mittal is not a parastatal anymore, but Thabazimbi mine still behaves as if it is. In recent years, Mittal cut off the capital expenditure supply, so, although they have too many trucks and so on, they are very old. However, they have not managed to operate competitively, carry a huge fixed cost burden, and are lumbering and inflexible to a changing environment. Sishen mine was successful in unshackling themselves from a captive mindset by the Saldanha export where only about a third of the mine operates on a captive basis, a throwback from the unbundling of Iscor a decade ago.

The huge challenge is to position and change the entire culture and mindset, to enable them to survive and start behaving as if they are not captive. Thabazimbi is currently facing such a culture challenge. Their production costs are higher than Mittal can obtain alternative or imported iron ore supplies. As Mittal has the option to take over the mine, a veritable sword of Damocles is hanging over the operation to get their act together. Much can be done to significantly improve efficiencies, but that will require difficult decisions. They have a very real burning platform which should improve the chances of making those decisions.