Threat of resource nationalism impact on mining companies by Beroe Inc

MAY | 2013

Threat of Resource Nationalism Impact on Mining Companies

Abstract: Rise in commodity prices drives mining investments especially in resource rich economies. However, governments in resource rich countries have been formulating regulations that enable them to exercise a greater control over the assets operated by miners, which in other words is termed as resource nationalism. Resource nationalism has been the common strategy adopted by the governments mainly owing to improper share of the resource benefits between the host nation and mining companies. Such policies incur significant additional costs for mining companies.. This article discusses about the impacts of resource nationalism on mining companies and the protective strategies adopted by mining companies to minimize the effects of resource nationalism, which in turn would benefit the host nationâ&#x20AC;&#x2122;s economy while ensuring sufficient returns to the Mining companies. Copyright ÂŠ Beroe Inc, 2013. All Rights Reserved

Introduction

Resource nationalism in developed economies

Recent boom in mining sector has encouraged more miners to invest in new

Increasing the mine royalty taxes has been a prevalent practice in developed

projects. In 2012, mining investment was expected to peak with global mining

nations. In July 2012, Australian government imposed Mineral Resource

capital expenditure at around USD 142 billion. However, certain business risks

Rent Tax (MRRT) which demands additional profit based taxes from mining

such as resource nationalism are expected to be a strong deterrent discouraging

companies extracting coal and iron ore. Australian government has estimated

investment into new projects. Owing to such business risks, the global mining

the total MRRT revenue to be about USD 10.6 billion by the end of 2015 with

capital expenditure is expected to decline by 10% per annum to USD 115 billion

major miners such as BHP Billiton, Rio Tinto and Xstrata expected to account for

by 2014.

90% of the MRRT revenue. However, government lowered its target to around USD 2 billion by the end of 2012 mainly owing to fall in commodity prices in

Mining capex in USD billion

Mining Capital Expenditure (2011-2014)

Q2 2012, rising cost of operations and a high Australian dollar which would strongly restrain mining companies from paying such high royalties.

200

Governments are also giving importance to retaining ownership of state owned

150

enterprises. In October 2012, Canadian government rejected Petronasâ&#x20AC;&#x2122; bid worth USD 5.23 billion to acquire Canadian state owned natural gas Company,

100

Progress Energy Canada Ltd. However, the bid was rejected due to Canadian

governmentâ&#x20AC;&#x2122;s desire to retain valuable resources and directly benefit from these resources.

0 2011

2012

2013 (F)

2014 (F)

Year

Why resource nationalism? Resource nationalism is attributable to the fact that mine profits are not appropriately shared between mining companies and the host nation. Resource

Resource nationalism is attributable to the fact that mine profits are not appropriately shared between mining companies and host nation.

nationalism, an act through which governments exercise a greater control over the assets from the mining companies has been known to pose significant threat to miners. A leading research firm rated resource nationalism as the biggest business risk for mining companies for the year 2012-2013. While many believe that resource nationalism is restricted to developing economies, this has been the trend in developed economies as well. About 25 countries across the world have already strengthened their policies that support increase in share of mining profits. Sudden policy changes by these governments have led the mining companies to reduce investment and in worst cases have led to shelving off the projects.

Mining industry is confronted by business risks that are expected to deter the global mining capital expenditure by 10% per annum to USD 115 billion by 2014.

Resource Nationalism in Developing Economies

Such dynamic nationalization laws have discouraged mining companies in

While resource nationalism in developed economies is less cumbersome, resource nationalism has been quite rigid in developing economies which would sometimes go far to the extent of expropriation. Stringent government policies that insist on exorbitant taxation, mandatory domestic beneficiation of unrefined ores and export levies are commonly adopted methods of resource

investing into new projects. Resource nationalism has affected FDI inflows in developing economies especially in Africa which recorded a decrease of 4.5% in FDI inflows in 2012 when compared to that of 2011. With nationalization laws becoming more stringent, FDI inflows in developing economies are expected to show a decreasing trend in the years to come.

nationalism in developing economies. Countries like South Africa, Indonesia,

Recently, Zimbabwean government imposed mandatory indigenization which

Ghana, Chile and Peru have already started implementing policy changes that

demands the foreign mining companies to give up 51% of their share to the

support resource nationalism.

locals. Revenue of USD 4 billion has been raised so far by the government after

In February 2012, Ministry of Energy and Mineral Resources (MEMR) of Indonesia passed a regulation which requires domestic processing of minerals and prohibits the export of raw materials to foreign countries for beneficiation. In order to effectively mandate domestic beneficiation processes, Indonesian

many foreign owned resource companies obliged to the indigenization law by ceding up 51% stake. In March 2011, Namibia announced “Strategic Mineral Policy” which demands strategic minerals like copper, coal, gold, uranium and platinum to be directly owned by a state mining company.

government has announced plans to levy additional tax of 25% on export of

Major miners’ concern over resource nationalism

unrefined ores and has plans to further increase to 50% by 2013. However

Resource nationalism became the major hurdle for Rio Tinto’s USD 6 billion

processes such as mineral beneficiation will require additional infrastructure,

worth Oyu Tolgoi (OT) mine in Mongolia. In October 2012, government of

energy and skilled labor which would incur significant additional costs for a

Mongolia announced plans to increase mine royalty tax for Oyu Tolgoi mine

mining company.

by USD 300 million. Further to this, the Mongolian government has plans to

Developing economies are also ensuring that there is a significant participation

increase its stake in OT mine from a current share of 34% to 50%. Indonesian government’s new mining law suggests cancellation of contract

steps to mandate 26% participation of indigenous people in mining operations

based foreign investments and supports investment based on licensing

as a part of Black Economic Empowerment. South Africa’s ruling party, African

system. The US based mining company, Freeport-McMoRan operates Grasberg

National Congress (ANC) has announced plans to levy windfall tax of 50% on

copper and gold mine in Papua province of Indonesia. Recently, the Indonesian

mining profits and 50% capital gains tax on sale of prospecting rights as a

government has demanded a 51% stake in the Grasberg mine and has also

part of increasing the state participation in resources sector and also to make

announced plans to elevate royalties from current 3.4% to 10%. Additionally,

significant addition to the nation’s revenue.

Freeport-McMoRan’s foreign investment contract is about to expire in 2021 and is currently negotiating with the Indonesian government to offer a 20

FDI Inflows into mining sector-Developing economies 300

250

200

150

100

0 2009

2010

2011

2012

Years Developing economies

FDI in Africa and LDC (USD billion)

FDI in developing economies (USD billion)

of state owned mining companies in their mining sector. South Africa has taken

year contract extension. However, government has disapproved the request according to Indonesian mining law of 2009. • Increasing mine royalties and retaining ownership of state owned enterprises has been the common trends followed by governments in developed economies • Mining companies in developing economies have been exposed to rigid nationalization policies that would sometimes travel to the extent of

Africa

LDC

expropriation of mines. • Developing economies have been enacting policies that demand mandatory state participation. Such dynamic nationalization laws have affected FDI inflows in developing economies like Africa.

Strategies to mitigate the risks of Resource Nationalism Infrastructure aid through Public Private Partnerships (PPP) Establishing partnerships with governments to aid in infrastructure development might be a potential solution for the big miners to attract significant support

• Mining companies have been investing in infrastructure by establishing partnerships with governments through Public Private Partnerships (PPP) • Recently, Rio Tinto established PPP with government of Guinea and has planned to invest in road and rail infrastructure surrounding the mine region

from local communities thereby avoiding nationalization of their operating

• Paladin, a prominent Uranium miner implemented SSMP through which

mines in developing economies. Resource rich countries like Zimbabwe, Congo

it has plans to improve infrastructure conditions in the area surrounding

and Zambia suffer from unemployment and poor infrastructure. While these are

Kayelekera mine in Malawi.

considered as hurdles for a mining company to incept its operation, the same

• Legal protective measures such as contract stabilization and BIT are being

can be viewed as a gateway to mitigate risk of nationalization of resources and

adopted by mining companies in order to minimize the financial risks due

contribute to the economic development of the country.

to resource nationalism.

Rio Tinto has implemented PPP for its Simandou mine in Guinea, West Africa. According to this partnership, Rio Tinto would aid the government in investment of road and rail infrastructure in the region where the mine is located. Government of Guinea currently holds 51% stake in infrastructure and 35% stake in Simandou mine.

EITI – An initiative to minimize the risks of Resource Nationalism EITI (Extractive Industries Transparency Initiative) has been initiated out of the need to establish a transparent transaction system between the foreign mining companies and the host nations. EITI demands mandatory disclosure

Prominent Uranium miner’s Management of Social Sustainability

of transactions happening between the governments and mining companies.

Paladin Energy Ltd, a prominent Australia based Uranium producer operates

of the host nation thereby gaining local community support which in turn would

Kayelekera mine situated in Northern region of Malawi where poor infrastructure

encourage more investment from foreign mining firms. EITI is based out of

conditions prevail. Recently, Paladin Energy Ltd established Social Sustainability

Norway. Currently, around 37 countries have successfully implemented EITI

Management Plan (SSMP). The initiative included plans to improve community

norms and its being supported by World Bank, some NGOs and key mining, oil

infrastructure by construction of school buildings, upgrading the existing district

and gas companies. Recently, Sierra Leone failed to disclose the transaction

hospital thereby contributing to local employment and staff skill development.

history as required by norms of EITI. Hence, EITI temporarily suspended Sierra

An estimated amount of USD 15 million was invested for SSMP by Paladin

Leone from global mining transparency board and has recommended corrective

Energy Ltd.

actions to be undertaken.

Such transparency showcases a miner’s share to the socio-economic benefit

Legal protective measures against resource nationalism Mining companies investing in foreign economies are susceptible to financial risks due to the ever changing law systems that support nationalization of mines especially in developing economies. Hence, it’s always necessary for a mining firm to minimize such risks by adopting protective strategies.

Protection of mining stabilization clauses

contracts

through

contract

Contract stabilization clauses is essential during contract negotiations between government and mining companies as it offers protection of contracts for a specified period of time against the local community’s right to alter the law. However, such law has been viewed upon as distrust by local governing bodies and NGO’s who fear such protective measures would disrupt country’s ability to enact initiatives that may stimulate economic development, and decrease poverty. Copyright © Beroe Inc, 2013. All Rights Reserved

Resource nationalism forcing miners to alter procurement strategy Procurement of personnel, goods and products from outside countries has been the traditional practice of resource companies operating in developing countries mainly owing to lack of domestic availability of quality goods from a miner’s perspective and ineffective engagement with local suppliers. Though the practice of procuring goods through local dealerships of multinational companies already exists, they were not observed to contribute significantly to the development of local content. Such practices are fading as there is increased pressure to develop local content. Nowadays, developing local content has shifted from a miner’s choice to an activity that is mandated by reforms. Governments have • Governments have been increasingly pressurizing miners to develop local content thereby adding significant economic benefits to the host nation

been increasingly pressurizing mining companies to adopt local procurement as their procurement strategy thereby generating domestic revenue that in turn would solve issues such as poverty, unemployment etc.

Legal Protection of resources through BIT and PRI Bi-lateral investment treaty (BIT) is another prevalent protective measure signed between the host nation and the foreign mining investors. Avoiding unlawful expropriation, equitable treatment of foreign investors and local investors, Protection and security of investment are some of the terms on which BIT is signed. An act violating the terms of BIT is imposed, the host nation is subjected to penalty in terms of financial compensation. In June 2012, Churchill Mining PLC a London based mining company filed a law suit against the Indonesian government as the latter violated BIT by revoking the former’s right to mine in Busang regency, Indonesia. However, the government cited that the mining company didn’t possess the correct mining licenses to mine in the site. Some countries have objected to the renewal of BIT as they believe BIT would restrain them from enjoying the benefits from domestic natural resources. Recently, South Africa rejected BIT renewal with European Union (EU). Private insurers such as Lloyds, London are issuing Political Risk Insurance (PRI) to the mining companies. PRI is a bilateral contract signed between the

• Revenue through Local procurement would be a lucrative option than adding

insurer and customers such as mining companies and it provides insurance

revenue through increased taxation. Recently, there has been an increased

against common risks of resource nationalism such as expropriation. PRI is

focus on local suppliers in providing core services to mining companies in

more flexible compared to BITs. However, PRI is premium in nature and cost of

developing economies.

PRI issued depends upon the region and the intensity of nationalization.

• Mine operations being complex, miners have increased focus on potential suppliers with proven track records thus excluding local suppliers from their portfolio.

Local Procurement - benefit to the host nation Local procurement would encourage more miners to invest in FDI if the services and products supplied by the domestic players nearly comply with the quality of the mining companies’ incumbents. Hence there is a need for government systems to finance local supply bases in order to cater to the demands of mining companies. Obtaining revenue through local procurement would be more

Recently in Ghana, a multinational oil company rejected a tender bid issued by a leading local supplier .GHEITI (Ghana Extractive Industries Transparency Index) claims that bid was rejected in spite of the supply being technically competent and relatively cheaper compared to tenders received from its incumbents.

A sound local content policy ensures effective local procurement

lucrative compared to revenues from increased taxation. Till now, developing

Emerging economies often suffer from lack of having a sound local content

economies have been successful in catering non-core services such as food

policy that facilitates effective local procurement. Rigid policies of resource

and beverage, software and packaging services to mining companies. Recently,

nationalism that mandates local procurement may induce unnecessary pressure

there has been an increased focus on providing core services to miners as it

on the mining company and may strongly deter from making investments.

would be a significant source of revenue for the local communities.

Recently, Government of Ghana set target of achieving 90% local content

As a result of local procurement strategy, the local supply base for mining

in the nation’s oil mining sector by 2020. However, Ghana currently lacks

in Brazil has expanded from 50% in 2003 to about 80% in 2010 thereby

sophisticated technology and skilled labor required to perform complicated oil

contributing USD 9 billion to the economy. In 2008, BHP Billiton’s Spence mine

mining operations. International Energy Agency (IEA) claims the target to be too

in Chile reported that 85% of the supplies to the mine were from domestic

ambitious and would be a difficult task to achieve.

suppliers thereby adding USD 485 million to Chilean economy. In 2010, Barrick

In African mining conference (Mining Indaba) conducted in South Africa on Feb

Gold’s Zaldivar gold mine contributed USD 285 million to Chilean economy

2012, some of the local suppliers claimed that local content development would

by procuring 70% of the mine supplies from domestic players. Local content

not be a feasible option unless the government facilitates access for capital

development is also prevalent in developed economies. Recently, Rio Tinto’s

required for their capacity expansions. Also, most of the contracts signed with

Diavik mine reported 90% of supplies from local players thereby contributing

local suppliers were short term which would result in business breakdown if

USD 1 billion to the indigenous groups.

the mining company suspends its operation owing to various economic factors.

Barriers to development of Local content

Policies induced by government in most of developing nations are instable

By engaging with domestic suppliers, miners have benefits of reduced lead

at times and often subject to change which would incur significant losses for

time and logistics cost, better bargaining power resulting in significant cost

the operating company. Hence there is a need for developing economies to

savings. However, mining companies are exposed to barriers while adopting

establish a collaborative approach in framing regulations and laws that ensure

local procurement strategy.

local content development.

Provided Mine operations are capital and labor intensive requiring complex procurement strategies, mining companies would generally prefer potential suppliers capable of providing superior quality products to meet their demands. Also the nature of contracts with suppliers being long term, procurement decisions are usually taken at a central level (global office) thereby minimizing opportunities for local suppliers in securing contracts. Some mines in developing economies are located in remote areas which are present at far distances from local community settlements thereby reducing chances of interactions between mine procurement officers and local suppliers. Though some local

• Governments in emerging economies are politically instable enacting

suppliers have the capability to cater to the challenging demands of mining

stringent nationalization policies. Also, such policies are instable thereby

industry, miners are under the perception that local suppliers wouldn’t match

deterring mine investments.

the expertise of their incumbents.

• There is a need for developing economies to build a collaborative approach in framing policies that support local content development.

Conclusion External investment is vital for development of mining industry especially in developing economies where there is lack of sufficient domestic capital and technology in spite of the availability of abundant resource rich deposits. However, developing economies have been unsuccessful in motivating foreign mining companies to utilize these natural resources by adopting nationalization strategies that demand a greater state control of resources from foreign investors. This has discouraged and deterred foreign mining investment. Hence, governments need to develop a balanced approach by rationalizing existing laws and regulatory framework to optimize revenue generation from foreign mining investment while enabling an investment friendly climate for mining companies to operate.

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Author: Sabarish Vaishnav A | Research Analyst

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