Box 3.4 Convergence of Mining and Hydrocarbons? ■
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Mining companies go to increasingly remote places to develop mines, requiring ports, power stations, and railway lines, so the upfront costs of getting established are rising, in line with oil. Mining companies are having larger impacts on the local economy. Examples are mining projects in Guinea and in Mongolia, increasing the size of local GDP hugely. Technology advances in oil and gas are making them closer to mining in the way they operate (shale bringing oil and gas on-land and with greater geographical dispersion). The recovery process from shale and tar sands resembles mining in economics and technologies more than the traditional extraction from deep underground wells; margins look more like mining due to higher cost. There is increasing similarity in the political challenges they face, especially in the impact of resource developments. Policy makers see similarities, too (as in discussions about Extractive Industries Transparency Initiative—see chapter 8).
Source: Humphreys 2014.
Companies in the EI sector routinely buy and sell their interests through mergers and acquisitions (M&As), usually on a friendly rather than a hostile basis. In the hydrocarbons sector, it is common for the buyers to be cash-rich NOCs from countries with insufficient domestic resource bases, such as China and India. Near the peak of the last commodity cycle, in 2011, the disclosed value of exploration and production M&A activity increased by almost 70 percent to reach US$317 billion (Ernst & Young 2011).11 Cash-rich NOCs from China and Korea played an important part in that activity. By contrast, in 2015 comparable M&A activity in hydrocarbons had fallen to US$71 billion once the giant merger between Royal Dutch Shell Group and BG is removed from the equation (Ernst & Young 2016, 6); it is US$153 billion when this transaction is included. Chinese and Asian NOCs were scarcely visible, with total NOC transactions declining to US$6.1 billion in 2015 from almost US$122 billion in 2012. The strong correlation between M&A and the commodity price environment means that with the substantial price fall, M&A activity has been in
decline for several years (as, for example, equity valuations fall and demands grow for returns of capital to shareholders). In a downward cycle, companies face limits on their M&A aspirations by uncertainty about the prospect of a commodity price recovery and (or alternatively) constraints on their balance sheets. Further, cross-border (as distinct from domestic) M&A has become increasingly challenged by the need for regulatory approvals to meet competition concerns by governments and even by what may be called cultural differences. For an international oil company (IOC), this kind of sale to an NOC (or other) buyer can be a way to raise funds for new projects. It can also be a way to generate a return from selling an asset that has been created by identifying commercially viable reserves. Its market value is derived from its future production potential. As the project matures, the share value increases, and a sale follows. This kind of IOC has a different business model from that of the better-known integrated oil and gas companies. (Exxon Mobil and Shell are examples of such companies.) Instead of producing oil from a successful exploration and generating a stream of cash to return to shareholders as dividend payments, it sells the asset at an early stage. In this way it avoids the complexity of bringing a large find into production, which requires significant upfront investment and often requires a JV structure to finance the development. Other IOCs may choose to produce discovered reserves themselves and may acquire other projects in order to gain access to the reserves they contain, thereby increasing the volume of reserves under their control (with or without having discovered them). A similar trend is evident in the mining sector, where the level of spending on M&As tends historically to be greater than that on exploration and development. However, here too there has been a reaction to the M&A transactions carried out in the years when commodity prices were high, with a severe decline in the volume and value of M&A transactions amid large impairment charges or write-downs of asset values that have followed these early deals. Separately, regulatory hurdles are a challenge for cross-border mining transactions, with governments reluctant to allow a transfer of ownership of resources to foreign companies, and a growing concern about loss of tax revenue that may follow from their approval. When M&A occurs, such activity reflects a transfer of ownership of the present stock of mines and associated processing facilities. Inevitably, its value is significantly higher than the value of annual additions to that stock, which derives from exploration and development. Just as in the
CHAPTER 3: THE EXTRACTIVE INDUSTRIES
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