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Making The Most Of Africa’s Resources

Making The Most Of Africa’s Resources

In the face of increasing demand, rising prices and profits, resource-rich countries in Africa are increasingly keen to make sure they’re getting a fair deal. How best to do so?

Prior to the global economic crisis of 2008, commodity prices had risen precipitously and they have since recovered to pre-crash levels. So now, as before the crisis, commodity-rich nations have watched keenly the increase in value of their exports and considered how they might share in the spoils.

The spoils are certainly considerable. Since the crisis, according to PricewaterhouseCoopers’ Mine 2011 report, the world’s top 40 miners have halved their debt, built cash reserves of $105bn, asset values have reached $1 trillion, revenues surpassed $400bn and profits topped $110bn last year. On top of that there is collectively $300bn in capital programmes already announced.

As this investment would suggest, despite the uncertain economic headwinds, demand for commodities remains resilient. Although there is significant volatility, as concerns persist about growth in Europe, the US and elsewhere, in the long term it is going to be immensely challenging logistically to produce the quantities demanded. Iron ore demand, for instance, is expected to increase by 50% between 2010 and 2016, from 1.8mt to 2.8mt.

China is also no stranger to concerns about its ability to maintain its phenomenal growth rate. Worries include the possible presence of a housing, or other asset class, bubble – if it is so hard for the market in its infinite and mysterious wisdom to allocate capital efficiently, can central planning by Beijing do any better? In the long term this remains to be seen. Nevertheless, so far so good; China continues to grow rapidly.

Since it consumes 40% of the world’s copper and around half of its iron ore, cement and coal, its performance is key to the commodities outlook. But even aside from China, a growing world population, and a general downward trend in the scale and ore quality of mineral finds all combine to increase the economic and political significance of major mineral deposits.

Inelastic supply

Commodity supply is, of course, relatively inelastic. It is necessary to raise money to spend on exploration and a miner must negotiate with a host nation to ensure a mutually satisfactory arrangement can be met. In order to attract investment, a sufficiently desperate nation may virtually give its mineral endowment away, whilst another may set its sights too high to get projects off the ground.

The matter is further complicated by the fact that the costs of, for example, establishing a mine are extremely high. Minerals are often located in out-of-the-way places. Offices, staff accommodation and rail and port connections may have to be built. This is on top of the cost of the expensive equipment required to drill the mine – with minerals such as gold now being found in deeper and deeper deposits.

The capital costs of taking a mining project from discovery to production are front-loaded. These large sunk costs for a miner may take years to recover – a mine may typically operate for 20 years. This exposes the company to the risk that a government or successor government may decide to levy a windfall tax, make changes to taxes such as royalties or even, in extremis, confiscate, nationalise (as Hugo Chavez did in the case of Venezuela’s gold mines) or even sell a mine.

Additionally, nations that have seen increases in miners’ profits as a result of higher prices but at the same time little or no increase in their own share of this wealth, can be tempted to act to take a larger share.

Assertiveness by countries over their resources is referred to as resource nationalism by the industry and, as previously reported in African Business, is the number-one concern amongst mining executives polled by Ernst & Young in a recent report.

There is some justification for these concerns. All across the world, from the US to Australia, China, Peru and Panama, the compact between government and miners is evolving. No less so on Africa’s lavishly endowed lands. The Democratic Republic of Congo has recently finished a wide-ranging review of mining licences. South Africa, which already has a 26% requirement for Black Economic Empowerment participation, introduced a new royalty regime in March with its Mineral and Petroleum Resources Royalty Act. Ghana plans to double its mining royalties, while Tanzania mulls over a windfall tax. Angola and Guinea have just introduced new mining codes, the latter mandating a rise in the level of state equity participation in projects from 15% to 33%. Zimbabwean law requires 51% participation by indigenous companies.

Naturally, countries want investment, jobs, skills transfer and miners want profits. Traditionally these needs have been seen as antagonistic – countries are either too greedy, demanding too much, and thus restricting investment, or too generous, attracting investment but at the expense of genuine economic development. But the fact is that the needs of both buyer and seller can be reconciled. Ways can be found that ensure that miners can be attracted and at the same time generate returns both for themselves and their hosts.

Reconciling opposed needs

There is already much being done towards reconciling the needs of industry and government – various strategies are being employed to this end. Miners need to maintain a social licence to operate. That is to ensure that their presence in host countries is not seen in a negative light and governments need to look at mitigating political risk (the risk of governments ‘moving the goalposts’ later in the day) and providing mechanisms that share profits in the good years whilst not throttling miners in the bad. Essentially, the key to determining the success of both industry and mineral exporting nations is the legal environment, internationally and domestically, in which they operate.

Good governance is the key. Nations must develop what British academic Paul Collier calls the “ethics of custody”, a clear vision of how their resources can be exploited in such a fashion that they provide most fully for not just the current generation but also those to come.

Resources have historically proved to be a curse for many nations, either due to the corruption they may foster or due to the Dutch disease, whereby the rest of the economy is distorted as a result of commodity income driving up the currency.

However, the lessons of history are there to be drawn on. The foolish Guinean junta’s $7bn deal in 2008 with China International Fund led subsequently to it being torn up by the newly elected government of President Condé, who pursuant to his mandate, has implemented a new mining code.

The code is regarded as hard but fair, with legal firm Clifford Chance commenting that “Guinea’s significant step towards greater transparency and tighter anti-corruption is to be applauded”.

The state takes a 15% stake in projects for free (with an option to purchase 20% more at market price) and raises taxes slightly but without precluding the possibility of profitable investment. The transparency measures aim to give more certainty and security for miners over the medium to long term too. The legislation also contains provisions related to corporate social responsibilities. The code is congruent with Guinea’s candidacy with the Extractive Industries Transparency Initiative (EITI).

The EITI, the Kimberley Process (which regulates diamonds) and the US’s Dodd-Frank Act are all international schemes which aim to increase transparency and to provide for the traceability of minerals. They are aiding efforts to minimise the potential for corruption and to stem the tide of conflict minerals.

These are desirable and admirable aims of course. The law of unintended consequences does applies – Dodd-Frank has allegedly led to a collapse in incomes in eastern DRC as companies wait for clarity on the proposals.

Meanwhile, those companies with little or no qualms continue to feast on minerals that come from dubious sources. Whilst the question of how effective these measures are in practice arises, their aims are laudable and a useful step in the right direction.

Whilst miners may be nervous about the impact of the assertive trend amongst host nations, the industry is recognising that its best response is to examine how it can ensure honest, open dealings with states. The desire by miners to make a profit and countries to secure the benefits of their endowments are both legitimate and need not be exclusive, they can be win-win. By entering into dialogue, companies can ensure they meet both parties’ needs by creating mutually viable economic and social compacts.

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Written by African Business Magazine

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