Small-cap miners 'devastated' by credit crunch

Sarah Arnott
Monday 17 November 2008 01:00

The toxic combination of falling commodity prices and the global financial crisis is wreaking havoc on small-cap energy companies in the oil, gas and mining sectors.

Oil and gas companies listed on the Alternative Investment Market (AIM) lost 44 per cent of their value in the third quarter of the year, an Ernst & Young report published today will say. Their mining counterparts lost an even more desperate 54 per cent, compared with the 35 per cent decline in the index as a whole, and raised a paltry £128m of funds, the lowest quarterly amount since 2004. The oil price has dropped from an all-time high of $147 per barrel in July to around $50 last week. Similarly traded metal prices have dropped through the floor over the past few months. Copper, for example, has dropped from more than $8,000 per metric ton to just above $3,500. Nickel has fallen from around $54,000 to nearer $9,000.

In the mining sector, even big players are having a hard time. Judging by forward price-to-earning (p/e) ratios, many are now looking unusually cheap. Kazakhmys has a p/e of around two times, Xstrata less than four, ENRC not much more. Even giants like BHP Billiton and Rio Tinto are on just 7.1 and 7.8 respectively.

Dr Tim Williams, director of global metals and mining at Ernst & Young, said: "These sorts of prices are clearly absurd, but the market is telling us prices are going to fall even further. In major mining stocks, the market is predicting Armageddon, a total meltdown in the world economy, and the complete collapse of demand." But at the smaller end of the scale, the industry is being reshaped altogether. Smaller companies in the sectors are largely prospective businesses: they buy licences, raise equity and conduct exploration. Only when resources are found are the claims either sold on, or developed in partnership. It is a business model that relies on being able to raise money.

With confidence falling, institutional investors such as hedge and commodities funds have sold out their positions, sending already-collapsing share prices even lower. Mercator Gold, for example, lost 87 per cent of its value in the third quarter alone, Serabi Mining, 95 per cent. Only the cash-rich will survive, and, according to Ernst & Young, fewer than half of AIM-listed mining companies had more than £5m in cash at the end of August. Dr Williams said: "These companies are completely devastated because, having never been able to raise debt, they now can't raise equity either."

The danger is that huge swaths of the research capacity of the sector will simply cease to exist, storing up considerable problems for future supply.

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