THE PARTICIPANTS

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Don Newport, director for mining and metals, Standard Bank
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Peter Ruxton, partner for minerals, oil and gas, Actis
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Tony Mahalski, chairman, Association of Mining Analysts O B Sisay, deputy head of Africa division, Exclusive Analysis
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O B Sisay, deputy head of Africa division, Exclusive Analysis
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Sean Cremin, director, SRK Consulting
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John McCarthy, contributing editor, The Banker

 

THE ISSUES

  • Africa’s opportunity to regenerate its economies and upgrade its infrastructure and productive capacity is strong while metal prices are at all-time highs
  • How should the issue of corruption be addressed?
  • Is the fiscal environment in Africa conducive to investment?
  • Environmental issues should be at the forefront of a project’s development
  • Progress on developing resources infrastructure
  • China’s involvement in African natural resources and infrastructure is growing

 

  • Africa’s opportunity to regenerate its economies and upgrade its infrastructure and productive capacity is strong while metal prices are at all-time highs

Natural resources are the linchpin of the African economy and the continent’s greatest cont- ributor to the global market. South Africa is the world’s largest producer of gold and a major producer of platinum, diamonds, coal, manganese and chrome. Gold sales account for more than 70% of Tanzania’s foreign exchange and 15% of the national gross domestic product. Africa also sources 43% of the world’s bauxite. Zambia is one of the world’s largest copper producers and Ghana is hugely dependent on mineral production and sales. Peter Ruxton, a partner for minerals, oil and gas at Actis, says: “Resources play a key part in Africa’s development. They provide the opportunity to develop a broader based economy should the governments of those countries and the international community wish to do so.”

Africa’s opportunity to regenerate its economies and upgrade its infrastructure and productive capacity has never been stronger, as metal prices are at all-time highs. This is at the core of the excitement that currently surrounds Africa’s mining activities. “Commodity prices have always been cyclical. Not so long ago we were talking 60 cents for copper [per pound]; today we are talking about $3 for copper. For the past five years, we have seen a very strong run in metal prices and it is difficult to see them coming down in the near future,” says Mr Ruxton.

The reason for the boom is growing demand from China and other developing countries. “China is sucking in steel and related metals to drive its economy,” says Mr Ruxton. “The iron and ore sector and the steel commodity sectors, such as manganese and chrome, and coal, have been driving the market forward in the past two years. Is this likely to stop? I don’t think so.” Similar pressures from Russia, Brazil and India will add to the demand for metals.

Bankers are less interested in current prices than in costs and profitability, says Don Newport, director for mining and metals at Standard Bank. “We are focusing on the scenario when the mine comes into production and over the period of production. That is going to generate the revenues that repay the debt.” He also warns that high prices may lead to substitution by cheaper alternatives. And the primary interest of the bank is its net margin (the amount that the mine will generate in terms of free cash).

Enthusiasm for the bull run in prices needs to be tempered by the rising costs associated with mining, says Tony Mahalski, the chairman of the Association of Mining Analysts. “This is the longest bull run in commodity prices in my career,” he says. “If prices come down, it is unlikely to be a train crash, as costs are rising all the time and margins will be eroded.”

Sean Cremin, the principal mining engineer at SRK Consulting, says that mining companies’ opportunities to benefit from boom times in metals are impeded by a shortage of skilled engineers. “There has been this tremendous boom. But the people you need to develop these projects are in very short supply. Many projects are starting up because of the boom, but there are not enough people with the skills. This is a tremendous problem.”

Those skills include the ability to see how mining can impact on a country’s political prospects and structure. O B Sisay, deputy head of the Africa division at political risk consultants Exclusive Analysis, says: “Where countries don’t have much of a diversified economy, quite a lot of political and security issues rise and fall with the fortunes of mining. So this is quite central not just to the economy, but also to how the country expands and prospers.”

Discussing all these topics at The Banker’s round table debate on the financing of resources in Africa were Mr Newport, Mr Ruxton, Tony Mahalski, the chairman of the Association of Mining Analysts, Mr Sisay and Sean Crimen, a director at SRK Consulting. The sponsored debate was chaired by John McCarthy, a contributing editor to The Banker, and this report was independently edited and written by Nick Kochan.

  • How should the issue of corruption be addressed?

Governments and investors alike wrestle with the scourge of corruption. This infects sectors as diverse as high-value mining of illegal diamonds, small-scale bunkering of oil and the mining of coal. Responses to this intractable problem take three basic forms. The first has a legal dimension and involves the policing of mining acts. The second is adopted at company level and involves tougher use of know-your-customer principles, and sharper due diligence of joint-venture partners and sources of funds. The third occurs at the country level and requires political change. Proponents of this route argue that corruption is endemic in poor countries where there is a single ruler or a single party. A strengthening fiscal and legislative environment is necessary if the first route is to be taken. “We need a stable fiscal environment,” says Mr Ruxton. “Countries need to bring in checks and balance to political power. They also need to build a business infrastructure and the business community that provides the key checks and balance that will eventually squeeze out issues such as major corruption.”

The second response calls for stronger applications of ethics policies within corporations. Companies that assist or actively collude with corrupt practices perpetuate the culture to the detriment of the larger sector.

Mr Newport advises managers to toughen due diligence procedures when taking on local partners. “It is essential to know the local guys that you are dealing with. It is a bit of a double-edged sword. On the one hand, you want to have a strong partner, a strong local guy, somebody who can tip you off if things are going to be difficult. The other side of that coin is that if they are too strong, you may find that they are busy ripping you off. A degree of local knowledge can help you avoid some of the pitfalls if you find somebody needs a bit of persuasion to grant a permit.”

Developments across the face of Africa suggest that the third solution, may be having some effect. Mr Sisay perceives two factors mitigating towards less corruption and greater democracy. The first is a “downward trend in wars”; the second is an “upper trend towards democratisation and reform”.

An assault on corruption from lobbying organisations can pull corrupt governments and companies into line, he says. “Companies are very worried about reputational risk, just as much as they are about financial risk. If you are a huge international operator, you do not want to be associated with a dodgy character down in Katanga. That can affect your reputation and ultimately investors’ confidence.”

Mr Mahalski takes a more sanguine view: “We are all victims of our own success. People were only smuggling things like gold or diamonds a few years ago. Now you price nickel and copper by the ounce. It is obvious that is the reason. We have got to get the commodity prices down and we will get rid of the corruption.”

THE KEY ISSUE:

  • Is the fiscal environment in Africa conducive to investment?

Africa has a long history of playing fast and loose with foreign investors. Contracts have been torn up with a change of government or if an investor appears to be making too much money. This has led to some inevitable cynicism about government intentions and reliability. But recent changes in statutes and regulation seek to give investors some reassurance. Many of Africa’s key resource-rich countries, including South Africa, Tanzania, Ghana and Zambia in particular, have passed strong mining acts and regulations. One catalyst for the passing of mining codes has been the World Bank, says Mr Ruxton. “The World Bank has insisted, indeed strongly encouraged, countries to bring in a mining framework, a mining code through which mining could take off.” A further source of certainty and security for investors has come with the adoption of the Extractive Industries Transparency Initiative (EITI), says Mr Sisay. “A lot of African countries are trying to sign up to the EITI because it is perceived as making you a lot more viable for investment,” he says. “Reforms will increase certainty of the political risk environment, which in turn encourages investment. This is so important because the amount of outlay involved in mining is so huge. You have to be certain that you are not going to get a guillotine come down on the investment in five years’ time,” says Mr Sisay. The conditions for investment in Africa are improving as its economies become better managed, he says. “A lot of African countries now have balance of payments and current account surpluses because of IMF intervention. A lot more African countries are now getting rated by credit rating agencies and that makes it possible for investors to go in.” Debt relief has been another factor in creating stable economies with a prudent fiscal framework. Fiscal stability and regulated mining sectors are far from universal across Africa, so countries at earlier stages of economic development will tend to have weaker legislation governing resources. Mr Cremin says: “Cameroon, Central African Republic and Chad have fledgling financial and mining structures. They are vying with each other for investment.” But the same caution needs to be exercised in the better-regulated countries. Legal infrastructure can be vulnerable to political interference, warns Mr Ruxton. He says that the flow of revenues from a mining project can prove to be very tempting to a government whose economy is, in every other way, in bad shape. Where this happens, governments will seek to extract some of the revenues from the mines for themselves, he says. “There is a cycle in most African countries where they decide that they want a mining industry and correct the fiscal framework to make that possible. But once they get into production and start seeing the revenue, they decide they want a larger share of the revenues,” says Mr Ruxton. The government’s windfall does not tend to last long, because the private sector reduces its investment in exploration, he says. When the falling revenue starts to pinch the government budget, means are found to restore the position of the private sector, and an equitable sharing out of the proceeds between government and private companies is arrived at. This game of cat and mouse between the government and the private companies has taken place in two of Africa’s key mining countries, Tanzania and Ghana. The former is seeking to reverse a pattern of state intervention in its gold industry that has cost it revenues and lost production. The latter has already gone a long way to repairing its relations with the mining companies.

  • Environmental issues should be at the forefront of a project’s development

Environmental pressures should be at the top of a mining company’s priority sheet, when it proposes a project. The number of agencies and authorities seeking satisfaction about compliance are numerous. Compliance impacts on every part of the project, from the cost and calculation of return through to the structuring, scale and geology of the project. Mr Sisay says: “There was a time when an environmental impact assessment (EIA) was a formality for a mining project in Africa. However, now you have more democratic involvement. These contracts get debated in parliament and you have IMF inspectors breathing down your neck, who are also taking a look at it. A west African gas pipeline project was halted on the basis of environmental and corruption issues. Huge power projects are also being looked at along those lines. The African governments themselves are moving on.”

Environmental issues need to be at the forefront of a project’s development, according to Mr Cremin. “I don’t think there is still enough emphasis put on the environmental aspects. The environmentalists are not brought in soon enough in the scoping and the pre-feasibility stages of projects.”

One source of pressure for compliance comes from investors, says Mr Newport. “No junior mining company is going to be able to develop a project of its own without going to some financial institution that says ‘sorry but you know this absolutely has to comply with world best practice’,” he says.

The impact of environmental concerns can be far-reaching. Mr Newport says: “I suppose the slightly worrying thing for the future is how far down this particular track you go. We have become conditioned into thinking that open cast mining is relatively cheaper than underground mining, but in an ideal world every open pit has to be refilled, landscaped and rehabilitated. I see the time coming when open pit mining just becomes completely uneconomic, not because of the mining costs but because of the rehabilitation.”

Mr Ruxton concurs with this pessimism. “What is often forgotten is that the footprint of the mining project is very small relative to the land area. If the environmental controls around the project are sufficient, the impact on the environment should be minimal.”

Mr Mahalski brings the environmental issues back to the production cost of mining. “All this merely does is to add the cost to the final product – end of story. This is what we are going to pay for,” he says.

  • Progress on developing resources infrastructure

As mining companies explore further afield and set up operations in more remote African countries and regions, lack of infrastructure becomes a more pressing and costly problem. “One of the major costs in a mine is fuel, and getting fuel into these places is becoming more and more expensive. This explains why operating costs are going through the roof,” says Mr Cremin. “Projects on the African continent are invariably absolutely miles from anywhere in terms of airfields, roads and rail.” The need to bring infrastructure to projects in Cameroon and Central African Republic has heaped about $500m on to the overall cost of each project, he adds. Investors have stepped into Africa’s infrastructural void, though, and a number of funds have been set up to invest in African projects. Fund managers say that the funds are flowing but the well-structured projects for investment are lacking. “There is a mismatch,” says Mr Ruxton. “A lot of money is available for infrastructure funding in Africa but there are not many projects. Africa has a tremendous need for infrastructure, as the Chinese are now discovering.”

One hurdle that investors encounter in structuring an infrastructure project is invariably political. Mining companies realise that they have a better chance of winning a mining concession if they structure infrastructure projects to provide a facility to the country.

Mr Newport says that mining companies are becoming more inventive: “If you are going to be putting in the infrastructure to develop a mine, then the mining company needs to examine other economic benefits it can bring to the region and other forms of infrastructure it can construct.”

He says that the building of a power system can be combined with the setting up of a mobile phone system and transportation links. “You should package the different projects and find different investors willing to get involved in them.”

  • China’s involvement in African natural resources and infrastructure is growing

China has targeted Africa’s natural resources as the primary investment opportunity. Chinese companies have stepped in where Western investors have lagged, to secure some major properties. Mining companies and banks in developed countries regard the large sums that the Chinese throw at African resource projects as speculative and inconsistent with established investment criteria. But African countries welcome Chinese involvement. It has not only served to advance their mineral production, but also to ensure that funds have been ploughed into Africa’s inadequate infrastructure. Shrewd Chinese involvement has given African countries both political and economic options.

China has established powerful footholds in Sudan, Angola and Congo, where it has made deals to buy oil and gas. It has also approached Nigeria to obtain options for the production of similar commodities.

“The Chinese are bringing not just the opportunity of off-take from Africa but they are committing serious amounts of money to building Africa’s infrastructure,” says Mr Ruxton. “They are showing the Western world the way forward. We have been reluctant to spend that sort of money on infrastructure in Africa. I think it is about time the West took note and started to at least match that spend.”

The processing of raw minerals has been a particular target of Chinese investment in Africa, says Mr Ruxton. “The Chinese are investing in the beneficiation [a variety of processes whereby extracted ore from mining is reduced to particles that can be separated into mineral]. This is a particularly necessary aspect. They are considering investing in smelting, for example, and are looking to build a nickel smelter and refinery in Zambia to produce the end product. This means that the country will reap the benefit in terms of jobs and associated benefits, rather than seeing it go abroad,” he says.

Enthusiasm for Chinese investment in Africa needs to be tempered by the political motive that drives it, says Mr Sisay. “The Chinese use resources as an instrument of foreign policy. The state is heavily involved and this reduces the importance of the pure economic imperatives for the long term or the short term. That is the core difference between the Western and Chinese investors.”

Chinese claims that their investments are free of political strings need to be regarded sceptically, he says. “Chinese companies will say that they are not going to get involved in your politics and that is probably the most pleasing thing to African politicians. But it is a fallacy if you think that China operates in places like Africa immune from political aspects.”

This cynical view of Chinese intentions is partly shared by Mr Cremin, who says: “They are bringing in their own people and massive funds, which are helping to develop the country. In the future, there is the possibility of political intervention.”

The key to understanding Chinese investment lies in its long-term perspective, something quite foreign to Western investors. “The West plays by a different set of rules to the Chinese,” says Mr Newport. “The Chinese invest with a very long-term strategy, which we find quite incomprehensible. There have been cases where they will build a railway line apparently into the middle of nowhere with several billion dollars worth of expenditure, on the basis a deposit will be found there at some time in the next 20 years. The usual discounted cash flow approach that we use does not make sense in this context.”LISTEN NOW:Audio recordings of the panellists in debate are available online. Hear the debate or individual chapters – visit thebanker.com/mediaSponsored by

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