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Understanding its key risks and developing appropriate responses to those risks is crucial to Anglo American's success

Principal risks and uncertainties

Anglo American is exposed to a variety of risks and uncertainties which can have a financial, operational or reputational impact on the Group and which may also impact the achievement of social, economic and environmental objectives. The principal risks and uncertainties facing the Group have been categorised into headline risk areas. The Group's approach to risk management is set out in the corporate governance section.

Key headline risks

Commodity prices

Commodity prices are determined primarily by international markets and global supply and demand. Fluctuations in commodity prices give rise to commodity price risk across the Group. Historically, such prices have been subject to substantial variation as illustrated by the volatility of prices in key commodities over the last two years shown below.

The impact of such volatility can result in material and adverse movement in the Group's operating results, asset values, revenues and cash flows. If the global economic environment remains weak for the medium to long term, the ability of the Group to deliver growth in future years may be adversely affected.

Falling commodity prices could prevent the Group from carrying out certain transactions that are important to the Group's business which may have an adverse effect on the Group's financial condition. An example would be the inability to find buyers for businesses or assets the Group may wish to sell.

Leveraging the diversified nature of the Group, the general policy is not to engage in commodity price hedging. The Group manages this risk through constant monitoring of the markets in which it operates and continuous review of capital expenditure programmes to ensure they reflect market conditions. A continuous focus on operating expenditure is also an important method of mitigating this risk.

Liquidity and counterparty risk

The Group is exposed to liquidity risk arising from the need to finance its ongoing operations and growth. If the Group is unable to obtain sufficient credit due to capital market conditions, the Group may not be able to raise sufficient funds to develop new projects, fund acquisitions or meet the Group's ongoing financing needs and, as a result, revenues, operating results, cash flows or financial position may be adversely affected.

The Group is also exposed to counterparty risk from customers or holders of cash that could result in financial losses should those counterparties become unable to meet their obligations to the Group. Cash deposits and other financial instruments, including trade receivables due from third parties, give rise to counterparty credit risk.

The Group has an experienced Treasury team who are responsible for managing the funding requirements of the Group and managing liquidity risk. Treasury also has a role to play in managing counterparty risk, particularly with banks where Anglo American places cash deposits. The Treasury operations of joint ventures and associates, including De Beers, are independently managed and may expose the Group to liquidity and other financial risks.

Currency risk

Because of the global nature of its business, the Group is exposed to currency risk where transactions are not conducted in US dollars or where assets and liabilities are not US dollar denominated. Fluctuations in the exchange rates of the most important currencies influencing operating costs and asset valuations (the South African rand, Chilean peso, Brazilian real, Australian dollar, euro and pound sterling) may adversely affect financial results to a material extent. Foreign exchange hedging is limited to debt instruments and capital expenditure on major projects.

Inflation

As the Group is unable to control the market price at which the commodities it produces are sold (except for any forward sales or derivative contracts), it is possible that significantly higher future inflation in the countries in which Anglo American operates may result in an increase in future operational costs without a concurrent depreciation of the local currency against the dollar or an increase in the dollar price of the applicable commodities. Cost inflation in the mining sector is more apparent during periods of high commodity prices as demand can exceed supply. In addition, any lag in the reduction of input costs against falls in commodity prices will have a negative impact on profit margins and financial results.

The Group manages costs very closely and during 2009 has reduced costs through a combination of headcount reduction, asset optimisation and supply chain initiatives.

Health and safety

Mining is a hazardous industry and is therefore highly regulated by safety, health and environmental laws. The failure to maintain the required high levels of safety management can result in harm to the Group's employees and communities near the mines and damage to the environment. This could result in fines and penalties, liability to employees and third parties for injury, impairment of the Group's reputation, industrial action or inability to recruit and retain skilled employees. Failure to provide a safe working environment may result in government authorities forcing closure of mines on either a temporary or permanent basis or refusing mining right applications. Changes in laws, regulations or community expectations can result in increased compliance and remediation costs.

Occupational health risks to employees and contractors include noise induced hearing loss, occupational lung diseases and tuberculosis. The Group provides occupational health services and continues to implement measures to monitor and limit the incidence and severity of such diseases. Anglo American sets a very high priority on safety and health matters, investing considerable resources in seeking to improve the safety performance of the Group's operations. The Group is constantly reviewing practices to improve safety performance and works closely with unions and governments, striving to produce a safer mining industry.

The Group recognises that the HIV/AIDS epidemic in sub-Saharan Africa is a significant threat to economic growth and development in that region. There is a risk that the recruitment and retention of skilled people required to meet growth aspirations may be adversely affected. Anglo American provides anti-retroviral therapy to employees with HIV/AIDS and also undertakes education and awareness programmes to help prevent employees and their families becoming infected or spreading infection.

Environment

Certain of the Group's operations do create environmental risk in the form of dust, noise or leakage of polluting substances from site operations and uncontrolled breaches of tailings dam facilities. Failure to manage environmental risks may result in harm to the Group's employees, the communities near the Group's operations and the environment, government authorities forcing closure of mines on a temporary or permanent basis or refusing future mining right applications. The Group could face fines and penalties, statutory liability for environmental remediation and other financial consequences which may be significant.

The Group is a large user of energy and one of the key commodities it produces is coal. Regulatory measures aimed at reducing emissions of climate changing gases may affect energy prices, demand for carbon intensive products such as coal and reduced margins on sales of coal.

Policy developments at an international, regional, national and sub-national level, including those related to the 1997 Kyoto Protocol and subsequent international agreements and emissions trading schemes such as the Emissions Trading System of the European Union, could adversely affect the profitability of the Group.

Assessment of the impact of climate change regulation is uncertain. The impact of climate change on the Group's operations is also uncertain and will depend on circumstances at individual sites. Potential impacts could include increased rainfall, flooding, water shortages and higher average temperatures. These may increase costs, reduce production levels or impact the results of operations.

The Group implements a number of initiatives to monitor and limit the impact its operations have on the environment. It also continually seeks to reduce energy input levels into its operations and the asset optimisation programme includes a number of energy saving initiatives.

Political, legal and regulatory

The Group's businesses may be affected by political or regulatory developments in any of the countries and jurisdictions in which the Group operates, including changes to fiscal regimes or other regulatory regimes which may result in restrictions on the export of currency, expropriation of assets, imposition of royalties and requirements for local ownership or beneficiation. Political instability can also result in civil unrest, nullification of existing agreements or mining leases and permits. Any of these threats may adversely affect the Group's operations or the results of those operations. The Group has no control over changes in local market interest rates or political acts which may deprive the Group of the economic benefits of ownership of its assets.

In January 2008, Minera Loma de Níquel (MLdN) was notified of the intention of the Venezuelan Ministry of Basic Industries and Mining (MIBAM) to cancel 13 of its exploration and exploitation concessions due to MLdN's alleged failure to fulfil certain conditions of the concessions. Further details are provided in the Nickel business unit overview section.

The Group recognises that its licence to operate through mining rights is dependent on a number of factors, including compliance with regulations. For example in South Africa, the Mineral and Petroleum Resources Development Act 2002 (MPRD) provides for conversion of existing mining rights (referred to as 'Old Order Rights') to 'New Order Rights', subject to the implementation of certain conditions. Failure to fulfil the specific terms of any of its licences, permits or other authorisations may result in withdrawal of mining rights, with resultant impact on financial performance.

The Group actively monitors regulatory and political developments on a continuous basis.

Supplier risk

The inability to obtain strategic consumables, raw materials, mining and processing equipment in a timely manner could have an adverse impact on results of operations and the Group's financial condition. During strong commodity cycles, increased demand can be experienced for such supplies, resulting in periods when supplies are not always available to meet demand or cost increases above normal inflation rates materialise. Any interruption to the Group's supplies or increase in costs adversely affects the Group's financial position and future performance. Anglo American has limited influence over manufacturers and suppliers, but takes a proactive approach to developing relationships with critical suppliers and improving the effectiveness of the Group's purchasing leverage through the One Anglo Supply Chain initiative.

Reserves and resources

The Group's mineral resources and ore reserves are subject to a number of assumptions, particularly the price of commodities, production costs and recovery rates. Fluctuations in these variables may have an impact on the long term financial condition and prospects of the Group.

Read more about the Group's policy on reporting of ore reserves and mineral resources.

Exploration

Exploration and development are speculative activities with no guarantee of success, but they are necessary for future growth. Failure to discover new reserves of sufficient magnitude could adversely affect future results and the Group's financial condition.

Anglo American invests considerable sums each year in focused exploration programmes to enable resource discovery and development to reserves.

Event risk

Damage to or breakdown of a physical asset, including risk of fire, explosion or natural catastrophe, can result in a loss of assets and subsequent financial losses. The Group's operations are exposed to natural risks such as earthquakes, extreme weather conditions, as well as the failure of mining pit slopes and tailings dam walls, fire, explosion and machinery breakdown.

Specialist consultants are engaged to analyse such event risks on a rotational basis and provide recommendations for management action to prevent or limit the effects of such a loss. In addition, the Group seeks to purchase insurance to protect against the financial consequences of catastrophic event, subject to the availability and cost of such insurance.

Employees

The ability to recruit, develop and retain appropriate skills for the Group is made challenging by global competition for skilled labour. The failure to retain skilled employees or to recruit new staff may lead to increased costs, interruptions to existing operations and delay in new projects.

A number of strategies are implemented to mitigate this risk, including attention to an appropriate suite of reward and benefit structures for existing employees and ongoing refinement of Anglo American as an attractive employee proposition.

Employees in the key countries where Anglo American operates are unionised and the risk of strike or other industrial relations disputes may have an adverse effect on the results of operations. Anglo American mitigates this risk through a process of constructive dialogue with trade unions and the maintenance of effective working relationships.

Contractors

Mining contractors are used at a number of the Group's operations to mine and deliver ore to processing plants, for example. In periods of high commodity prices, demand for contractors may exceed supply, resulting in increased costs or lack of availability of key contractors. Disruption of operations or increased costs can occur should there be disputes with contractors or unavailability of certain skills.

Business integrity

Many countries where the Group's operations are located have increased their emphasis on enforcement of laws to which the Group is subject, including safety, environmental, antitrust and anti-corruption. The Group has provided clear standards of conduct to promote full compliance with laws; however, non-compliance with these standards may lead to prosecution and other litigation and adverse effects on the Company's profits, licences and reputation.

Operational performance and project delivery

Failure to meet production targets can result in increased unit costs, which are pronounced at operations with higher levels of fixed costs. Variable unit costs may also exceed forecasts, adversely affecting performance and the results of operations.

Failure to meet project delivery times and costs could have a negative effect on operational performance and lead to increased costs or reductions in revenue and profitability.

Increasing regulatory, environmental, land access and social approvals can result in significant increases in construction costs and/or significant delays in construction. These increases could materially and adversely affect the economics of a project, the Group's asset values, costs, revenues, earnings and cash flows.

A number of strategies have been implemented to mitigate these risks, including management oversight of operating performance and project delivery through regular executive management briefings, increased effectiveness of procurement activities through the One Anglo Supply Chain and other business improvement initiatives to reduce unit costs and improve delivery of capital projects.

Acquisitions

The Group has undertaken a number of acquisitions in the recent past. With any such transaction there is the risk that any benefits or synergies identified at the time of acquisition may not be achieved as a result of changing or incorrect assumptions or materially different market conditions or deficiencies in the due diligence process, resulting in adverse effects on financial performance, production volumes or product quality. Furthermore, the Group could find itself liable for past acts or omissions of the acquired business without any adequate right of redress.

Rigorous guidelines are applied to the evaluation and execution of all acquisitions that require the approval of the Investment Committee and Group Management Committee and, subject to size, the Board.

Infrastructure

Inadequate supporting facilities, services and installations (water, power, transportation, etc.) may affect the sustainability and growth of the business, leading to a loss of competitiveness, market share and reputation. The potential disruption of the ongoing generation and supply of power is a risk faced by the Group in a number of countries in which it operates, including South Africa. Anglo American's approach to addressing this risk is to work jointly on developing sustainable solutions to these problems with suppliers of infrastructure services and facilities.

Anglo American relies upon effective rail and port facilities for its products and will be expected to provide shipment of product in some circumstances to customers' premises. Failure of rail or port facilities may result in delays and increased costs as well as lost revenue and reputation with customers. Failure to procure shipping costs at market rates may reduce profit margins, thus reducing profit levels.

The Group seeks to work closely with suppliers of rail and port infrastructure to mitigate the risk of failure and establish contingency arrangements. Services are provided to customers who require product to be delivered to them and purchase of shipping capacity is aligned to the needs of Group companies.

Community relations

The Group operates in several countries where ownership of rights in respect of land and resources is uncertain and where disputes in relation to ownership or other community matters may arise. These disputes are not always predictable and may cause disruption to projects or operations. The Group's operations can have an impact on local communities, including the need, from time to time, to relocate communities or infrastructure networks such as railways and utility services. Failure to manage relationships with local communities, government and non-governmental organisations may disrupt operations and adversely affect the Group's reputation, as well as its ability to bring projects into production.

The Group has developed comprehensive processes to enable its business units to effectively manage relationships with communities and actively seeks engagement with all affected communities impacted by the Group's operations.

Joint venture relationships

Some of the Group's operations are controlled and managed by joint venture partners, associates or by other companies. Management of non-controlled assets may not comply with the Group's standards, for example, on safety, health and environment. This may lead to higher costs, lower production and have a negative bearing on operational results, asset values or the Group's reputation.

Anglo American seeks to mitigate this risk by way of a thorough evaluation process before committing to any joint venture and implementation of ongoing governance processes in existing joint ventures.

Critical accounting judgements and key sources of estimation and uncertainty

In the course of preparing financial statements, management necessarily makes judgements and estimates that can have a significant impact on the financial statements. The most critical of these relate to estimation of the useful economic lives of assets and ore reserves, impairment of assets, restoration, rehabilitation and environmental costs and retirement benefits. The use of inaccurate assumptions in calculations for any of these estimates could result in a significant impact on financial results.

Useful economic lives of assets and ore reserves estimates

The Group's mining properties, classified within tangible assets, are depreciated over the respective life of the mine using the unit of production (UOP) method based on proven and probable reserves. When determining ore reserves, assumptions that were valid at the time of estimation may change when new information becomes available. Any changes could affect prospective depreciation rates and asset carrying values.

The calculation of the UOP rate of amortisation could be impacted to the extent that actual production in the future is different from current forecast production based on proven and probable mineral reserves.

Factors which could impact useful economic lives of assets and ore reserve estimates include:

  • changes to proven and probable mineral reserves;
  • the grade of mineral reserves varying significantly from time to time;
  • differences between actual commodity prices and commodity price assumptions used in the estimation of mineral reserves;
  • renewal of mining licences;
  • unforeseen operational issues at mine sites; and
  • adverse changes in capital, operating, mining, processing and reclamation costs, discount rates and foreign exchange rates used to determine mineral reserves.

The majority of other tangible assets are depreciated on a straight line basis over their useful economic lives. Management reviews the appropriateness of assets' useful economic lives at least annually and any changes could affect prospective depreciation rates and asset carrying values.

Impairment of assets

The Group reviews the carrying amounts of its tangible and intangible assets to determine whether there is any indication that those assets are impaired. In making the assessment for impairment, assets that do not generate independent cash flows are allocated to an appropriate cash generating unit (CGU). The recoverable amount of an asset, or CGU, is measured as the higher of fair value less costs to sell and value in use.

Management necessarily applies its judgement in allocating assets that do not generate independent cash flows to appropriate CGUs, and also in estimating the timing and value of underlying cash flows within the value in use calculation. Factors which could impact underlying cash flows include:

  • Commodity prices and exchange rates;
  • Timelines of granting of licences and permits;
  • Capital and operating expenditure; and
  • Available reserves and resources.

Subsequent changes to the CGU allocation or to the timing of or assumptions used to determine cash flows could impact the carrying value of the respective assets.

Restoration, rehabilitation and environmental costs

Provision is made, based on net present values, for restoration, rehabilitation and environmental costs as soon as the obligation arises. Costs incurred at the start of each project are capitalised and charged to the income statement over the life of the project through depreciation of the asset and the unwinding of the discount on the provision. Costs for restoration of subsequent site damage are provided at net present value and charged against profits as extraction progresses. Environmental costs are estimated using either the work of external consultants or internal experts. Management uses its judgement and experience to provide for and amortise these estimated costs over the life of the mine.

Retirement benefits

The expected costs of providing pensions and post retirement benefits under defined benefit arrangements relating to employee service during the period are charged to the income statement. Any actuarial gains and losses, which can arise from differences between expected and actual outcomes or changes in actuarial assumptions, are recognised immediately in the Consolidated statement of comprehensive income.

Assumptions in respect of the expected costs are set after consultation with qualified actuaries. While management believes the assumptions used are appropriate, a change in the assumptions used would impact the earnings of the Group going forward.

Average commodity prices and currency sensitivity analysis in respect of currency and commodity prices

  Average price(1) 10% sensitivity
US$ million(6)
Commodity 2008 2009
Platinum(2) $1,585/oz $1,211/oz 137
Metallurgical Coal(3) $190/t $142/t 103
Thermal Coal(3) $79/t $68/t 147
Copper(4) 315 c/Ib 234 c/lb 222
Nickel(4) 953 c/Ib 667 c/lb 39
Iron Ore(5) $88/t $65/t 80
Palladium(2) $355/oz $266/oz 17
ZAR/USD 8.27 8.41 293
AUD/USD 1.17 1.26 110
CLP/USD 524 559 29
GBP/USD 0.54 0.64 32
(1)
'oz' denotes ounces, 't' denotes tonnes, 'c' denotes US cents, 'lb' denotes pounds.
(2)
Source: Johnson Matthey plc.
(3)
Group average realised FOB price of metallurgical coal and thermal coal.
(4)
Being the average LME price.
(5)
Average price represents average iron ore export price achieved.
(6)
Excludes the effect of any hedging activities. Stated after tax at marginal rate. Sensitivities are the average of the positive and negative and reflect the impact of a 10% change in the average prices received and exchange rates during 2009. Increases in commodity prices increase underlying earnings and vice versa. A strengthening of the South African rand, pound sterling, Australian dollar and Chilean peso relative to the US dollar reduces underlying earnings and vice versa.

Basis of disclosure

This operating and financial review (OFR) describes the main trends and factors underlying the development, performance and position of Anglo American plc (the Group) during the year ended 31 December 2009, as well as those likely to affect the future development, performance and position. It has been prepared in line with the guidance provided in the reporting statement on the operating and finance review issued by the UK Accounting Standards Board in January 2006.

Forward looking statements

This OFR contains certain forward looking statements with respect to the financial condition, results, operations and businesses of the Group. These statements and forecasts involve risk and uncertainty because they relate to events and depend on circumstances that occur in the future. There are a number of factors that could cause actual results or developments to differ materially from those expressed or implied by these forward looking statements.

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Annual Report 2009