London, 9 June 2011: Reuters

Consensus forecasts for miners' earnings are failing to price in the full impact of rising costs, a gap that could trigger a correction in the sector's shares after the summer results season. Rises in both capital and operating costs have become a growing problem for the booming industry, which faces ever higher price tags for everything from skilled labour to power, maintenance and even explosives and prefabricated buildings.

The industry has also been hit by a weakened U.S. dollar -- the currency in which most report. "It would appear the Street is forecasting flat or only slightly increasing costs, and we would disagree, certainly if prices go any higher," analyst Paul Galloway at Bernstein Research said.

"I think that anyone ignoring (cost pressures) is likely to be disappointed when it comes to half- or full-year numbers." Miners themselves have warned since the start of the year that costs, which eased during 2008 and 2009, have begun to rise again. Even low-cost players such as Anglo American see a return to the double-digit increases seen before the crisis. According to Bernstein Research, a simple average of first quarter unit cost increases announced in recent weeks suggested they have risen by some 18 percent year-on-year. Kazakh-based ENRC , one of few miners to detail costs so far this year, last month forecast its unit costs would rise 15-20 percent this year.

But average forecasts for year-on-year cost increases of the top four companies -- according to earnings forecasts from Thomson Reuters I/B/E/S/ -- came in at 12.5 percent for 2011 and 5.6 percent for 2012, excluding amortisation and depreciation.

The first months of this year include the impact of freak weather across the southern hemisphere, which battered production and lifted unit costs. Volumes and cost comparisons will recover, but analysts agree it has not been a good start.

"If people are not factoring in cost inflation this year, they probably will be by the end of the results season," analyst Nik Stanojevic at investment manager Brewin Dolphin said.

"I am not sure how it affects the investment case for mining companies in the long term, but in the short term you could see downgrades and a relatively modest correction."

WAGE INFLATION

The reasons for cost inflation vary by region, but top precious and base metals producer nations South Africa, Australia, Chile and Canada have in common strong domestic currencies, rising labour costs and surging energy costs.

Barclays Capital analyst Gayle Berry said one of the top causes of inflation has been labour, with an acute shortage of skilled manpower looming in some countries. Canada's mining sector, she said, is forecast to have a

shortfall of almost 100,000 workers in the next decade, with 65 percent of the hiring requirement simply to replace retired workers. Plugging that hole will be tough and expensive. "The first impact is on mine production costs, which are going to continue rising, and the second impact is the potential for delays to new projects, or at the very least a slower realisation of projects in the pipeline," Berry said.

Western Australia is a flashpoint for labour costs, with mining companies competing for skilled labour with several large natural gas projects. "Investors are wary of investing in new gold mining projects in Australia because of the high cost of achieving production in that region," said John Meyer, a mining analyst at Fairfax.

In South Africa, the National Union of Mineworkers is demanding an above-inflation 14 percent rise in wages this year. At the same time, the currencies of producer countries including South Africa, Australia, Canada and Chile have risen, eating into profits of companies that sell their metals in dollars and pay their costs in local currencies. The South African rand has gained 14 percent in the past 12 months, while the Australian dollar is up around 30 percent compared with one year ago.

The price of Brent crude has risen more than 45 percent in the past year, pushing up energy costs particularly for producers of energy-intensive metals such as aluminium. In South Africa, state-owned electricity producer Eskom has been given the go-ahead to raise electricity prices 25 percent per year over three years.

Although all mining companies will feel the impact of cost inflation, the bigger diversified miners such as Rio Tinto , Anglo American and BHP Billiton are likely to suffer less than smaller or more focused miners.

"Don't forget these are companies with very large margins: if Rio is selling iron ore at $130/tonne and costs go from $25-$30 or $30 to $35/tonne -- that is double-digit cost inflation, but it is not really going to change the investment case," Stanojevic said.

These companies also are able to use their size to help manage costs. For example, Xstrata is using a standard concentrator design that can be bought in bulk for its copper projects, ensuring consistent standards and economies of scale.

"Economies of scale are the obvious reaction to increasing costs, and that's why mines tend to be on a larger scale now compared to previous decades," said Credit Agricole analyst Robin Bhar.

Ends --

By Clara Ferreira-Marques and Sue Thomas – for Commodities Now.