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Barrick Gold's Lagunas Norte in Peru.

Barrick Gold

Mining companies are discovering the flip side of the commodities boom: soaring costs.

Metal and mineral producers have long enjoyed high-flying commodity prices, but they're increasingly becoming victims of their own success amid surging costs for everything from energy and raw materials to labour.

Even as they report record earnings thanks to strong metal prices, miners are being hit with sharply higher price tags for new projects and existing operations as they spend heavily to ramp up production to meet intensifying global demand, particularly from China.

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Barrick Gold Corp. , the world's largest gold producer, said Thursday that capital expenditures on three of its development projects have risen by a total of about $2-billion (U.S.) due to higher labour, energy and raw material costs as well as general inflation.

Earlier this week, BHP Billiton Ltd. , the world's largest diversified miner, said higher fuel and energy prices and increased labour costs reduced its profit by about $500 million for the last half of 2010. Higher costs also weighed on recent profits at Toronto-based producers Kinross Gold Corp. and Agnico-Eagle Mines Ltd.

"Cost inflation appears to have returned to the mining industry with a vengeance," TD Newcrest analyst Greg Barnes wrote in a note to clients.

It's a Catch-22 for miners. While inflation helps drive up the price of some of their products - gold, for example, is purchased as an inflation hedge - it also pushes up production costs. Miners have little choice but to pay higher wages and spend more on energy and raw materials to pump out more product and capitalize on growing demand.

For Barrick, the biggest cost increase is at its Cerro Casale project in Chile, which is now expected to rise up to 25 per cent to more than $5-billion. That's up from a projected cost of $4.2-billion last year.

Barrick also expects the capital cost at its Pueblo Viejo development project in the Dominican Republic to rise by 10 to 15 per cent to about $3.5-billion, and its Pascua Lama project on the border of Chile and Argentina to rise up to 20 per cent to around $3.6-billion.

Some of the company's overall cost increases are the result of geography, said Barrick chief executive officer Aaron Regent.

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For instance, he pointed to the "heated labour environment" in Western Australia, where employee turnover at Barrick's operations is around 30 per cent. Barrick is competing for workers alongside other operations in the region run by rivals such as BHP and Rio Tinto.

In Argentina, rising inflation has resulted in renewed labour contracts with wage increases of up to 30 per cent, Mr. Regent said.

In Chile, Barrick is not only competing with other miners for workers, but also construction companies rebuilding infrastructure devastated by last year's earthquake.

"There's competition for resources," Mr. Regent said in an interview. "It's people, it's contractors, it's engineering firms. Those things are hitting us. Commodity prices are up, steel prices are up. It's a combination of factors which add up and have an impact."

Australian-based BHP said higher costs, coupled with the impact of a falling U.S. dollar against currencies in other countries where it operates, reduced its earnings by about $1.4-billion from July to December. More than a third of that is the result of higher fuel and energy prices as well as increased maintenance, labour and contractor costs, BHP said.

"Capital and operating cost pressures are a very real and unavoidable consequence of the strong commodity cycle and weak U.S. dollar and BHP Billiton is not immune to that trend," chief financial officer Alex Vanselow told analysts this week. BHP also revised capital spending and schedules at some of its projects as a result of higher raw material and labour costs.

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Still, miners say commodity prices continue to rise far faster than costs.

"The higher commodity prices are also significantly improving the economics of our projects," Mr. Regent told investors after the release of the company's latest financial results on Thursday. "While the capital costs have increased somewhat, the economics and returns of investment in capital continue to be very, very good."

Outside of cutting costs, Barrick hedges oil and currencies to try to prevent large swings in its earnings amid volatile prices.

Rising prices can also be a benefit to large companies like Barrick, which can use it as an opportunity to buy into new projects that smaller competitors may not be able to afford. Last year for example, Barrick increased its stake in Cerro Casale to 75 per cent from 50 per cent after buying an increased portion from project partner Kinross. That deal happened as estimates to build the mine rose to $4.2-billion from $3.6-billion.

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