Sub-Saharan Africa (SSA) holds vast mineral wealth, yet many of the region’s currently identified deposits have remained undeveloped for decades. By Glen Ireland, partner, Latham & Watkins.
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The Republic of Guinea, for example, is endowed with large, high-grade bauxite and iron ore resources, but has not benefited from a new greenfield mine in more than 40 years. This lack of progress has led to profound frustration on the part of many SSA governments seeking to achieve greater economic growth and prosperity for their peoples. In addition to generating much needed royalty and tax receipts, and local employment opportunities, new world-class mining projects may have the potential to catalyse broad-based economic development in the region.
Why is SSA, generally viewed as the global mining industry’s last great frontier, failing to realise its full resource potential?Certainly, political instability, resource nationalism (in all its forms), and challenging global economic conditions have played a role in limiting progress. But on closer examination, these factors may not provide a complete explanation. For example, they have not prevented offshore oil and gas investment in SSA from expanding rapidly, and jurisdictions with “risk profiles” similar to SSA (eg, in Central Asia and South America) have experienced strong mining activity for many years. This raises the question: Is there something uniquely challenging about large-scale mining in Africa?
Increasingly, mining industry observers and African experts are focusing on the challenges associated with transportation infrastructure required to support major mining projects in SSA. A significant proportion of the world-class deposits in SSA that await development are located far from the African coast, in some cases more than 700km.
In general, conveniently sited rail and port facilities to support these projects do not currently exist and need to be constructed, often through challenging terrain. In the small number of situations where existing infrastructure is available, it invariably requires major improvement and/or capacity expansion to meet the needs of a large-scale mine. Deutsche Bank has estimated that more than 4,000km of greenfield railway, costing in excess of US$50bn, will need to be financed and constructed to unlock Africa’s iron ore deposits alone.
The financial and technical challenges associated with developing mining infrastructure on such a massive scale are, unfortunately, further complicated by a lack of consensus among key stakeholders on how such infrastructure should be implemented.
International Finance Corporation (IFC) recently published a report (Fostering the Development of Greenfield Mining-Related Transport Infrastructure through Project Finance, April 2013) highlighting the myriad challenges associated with mining infrastructure in SSA. Vale Columbia Centre on Sustainable International Investment, affiliated with Columbia University in New York City, is currently studying ways to leverage mining infrastructure to achieve broad economic development in SSA. Other similar international initiatives are also under way. All of this work demonstrates the need to reach a consensus on a number of critical questions, including:
* Who should construct, own and operate mining infrastructure?
* What approach should be taken to raising the required capital?
* Who should have the right to use the infrastructure?
The integrated mining model
Transportation infrastructure is critical to the success of large-scale mining operations. Mining companies generally seek infrastructure solutions that deliver optimal economic returns over the life of the mine (ie, in terms of capital and operating costs), while minimising construction and operating risks, providing a secure route to market and preserving flexibility to reduce or expand mine output.
Although it is not uncommon for older “legacy” mines in developed countries to utilise third-party owned rail or port facilities, mining companies generally regard these arrangements as unattractive. When planning greenfield projects, mining companies typically seek to own, operate and have the exclusive right to use the associated transportation infrastructure, even if this means greater initial development costs. This “integrated” mining/infrastructure approach has been successfully employed throughout the world, including in the iron ore-rich Pilbara region of Western Australia.
It is unsurprising, then, that mining companies are generally seeking integrated (and exclusive) infrastructure solutions for their large-scale mining projects in SSA. However, a confluence of factors has recently led some to question whether the integrated model is the most appropriate approach. These factors include:
* Infrastructure cost – The projected cost of developing mining infrastructure in SSA is now expected, in many cases, to exceed the cost of building the associated mine (often by a wide margin). With mining companies’ earnings being impacted by weak commodity prices and a sluggish global economic recovery, even the majors will be stretched to finance the huge sums required.
* Shareholder activism – Over the past five years, shareholders of many mining companies have suffered from ill-timed and often poorly executed mining projects and transactions. With many companies having recently announced multi-billion dollar asset impairment charges, their management teams now have a strong incentive to find creative ways of reducing capital expenditure and returning more cash to investors.
* Open access agenda – SSA governments, emboldened by the African Mining Vision report (adopted by African heads of state in February 2009) and related initiatives, are now insisting that newly constructed mining infrastructure be operated on an open access basis. The goal is to open up rail, port and other facilities to other industries (eg, agribusiness and passenger rail) and “secondary” mining projects so as to maximise the linkages between large-scale mining operations and the local economy. Governments are becoming increasingly sophisticated in negotiating detailed and enforceable open access commitments into mining concession agreements.
* Threats to the integrated model – The exclusive rights of integrated mining operations to use their infrastructure are increasingly under threat around the world. For example, government authorities in Australia have introduced comprehensive regulations designed to facilitate third-party access to the iron ore railways in the Pilbara. These authorities have also insisted that new infrastructure, such as that recently constructed by Fortescue Metals Group, be operated on an open access basis. The owners of Pilbara rail infrastructure have, so far, successfully resisted attempts by third parties to gain access. However, it seems only a matter of time before the benefits of the integrated model are eroded in Australia and elsewhere.
* Government pressure to develop – In the current global economic climate, most mining companies are hoping to defer major investment decisions on greenfield mining projects. However, some SSA governments are taking an aggressive stance on the timing of development decisions, and are vigorously enforcing agreed development milestones. Certain SSA governments have recently taken steps to terminate, expropriate or reallocate mineral rights, informally applying a “use it or lose it” policy. As pressures mount on mining companies to commit to new projects in a period of economic uncertainty, they will need to find creative ways to reduce and/or share the risks involved.
* Resource-for-infrastructure deals – Well-funded Chinese state-owned entities (SOEs) are aggressively seeking to acquire mineral rights in SSA. They are conscious of the region’s infrastructure deficit, and have cleverly offered to make significant investments in roads, schools, hospitals and similar facilities in exchange for access to mineral resources. While the details of these resource-for-infrastructure or R4I deals are murky, the SOEs appear to have a high tolerance for risk and be focused on strategic considerations rather than short-term economic returns. R4I deals in SSA represent a significant threat to the growth prospects of Western mining companies, and they demand a competitive response.
What are the alternatives?
While there might be a strong case for moving away from the integrated mine/infrastructure model in SSA, it is not clear what alternative approach to developing the infrastructure can or should replace it. In developed countries, public infrastructure projects are typically funded or supported by government. However, this approach is unworkable in most frontier SSA countries. IFC concludes, for example, in its report that “given the large size of infrastructure needs relative to SSA countries’ GDP and public budget, the financial commitment of one project could overwhelm a country’s entire budget equilibrium”.
Another option would involve mining infrastructure being financed, constructed, owned and operated by a private special purpose vehicle (SPV) in a structure similar to public-private partnerships. But is a bankable SPV structure achievable and, if so, could it satisfy both the open access objectives of host governments and the operational requirements of large-scale mining?
Features of a mining infrastructure SPV
An infrastructure project developed to support a large-scale mining project would, from the outset, benefit from a significant, long-term customer (the first-mover mining client). Given the interdependence of the mine and infrastructure projects, an infrastructure SPV should be able to obtain from its mining client a long-term take-or-pay (TOP) commitment to use and pay for access to the infrastructure. If the TOP commitment is given, or guaranteed, by an investment-grade entity, it would represent a strong foundation on which a bankable SPV model could be built.
A viable mining infrastructure SPV model would require sufficient flexibility to accommodate the legitimate requirements of the host government, the first-mover mining client and future third-party users. At a minimum, an SPV structure would need to provide for the following:
* Founder rights – The first-mover mining client will inevitably demand founder rights, in recognition of the importance of its TOP commitment in supporting the financing and development of the infrastructure. The nature of such rights would need to be negotiated on a case-by-case basis, but could involve priority access and the right to implement future expansions.
* Political input – A host government should have the right to determine the types of industries (eg, agribusiness vs. passenger services) that are entitled to gain access to unutilised infrastructure capacity, consistent with the country’s political and economic priorities.
* Admission of new users – The SPV would need to accept applications from third parties seeking access to the infrastructure, and make access decisions based upon pre-agreed and objective criteria. All third-party users would need to meet certain minimum requirements relating to operational capability, condition of rolling stock or other equipment, insurance arrangements and financial capacity. Rights of access by new users would, of course, be subject to any founder rights awarded to the first mover mining client.
* Infrastructure/modification expansion – It may become necessary to undertake modifications and/or expansions to the physical infrastructure assets as new users are added to the network or the needs of some users increase. Lenders to the SPV would need to permit such changes, provided that they were fully funded and that the SPV did not take on excessive operational, technical or financial risk.
Advantages of a mining infrastructure SPV
A well-structured mining infrastructure SPV model could have a number of significant advantages over the more traditional integrated mine/infrastructure approach, including:
* New sources of capital – A mining infrastructure SPV could attract debt and equity investment from infrastructure funds, development banks and other capital providers that are unable to invest in integrated mining projects or otherwise assume commodity price exposure. Given the vast sums required for mining infrastructure in SSA, the opening up of new sources of capital would be a welcome development.
* Lower cost of capital – Under an integrated approach, the entire mine and infrastructure project must exceed the mining company’s hurdle rate based on its (relatively high) cost of capital. If the infrastructure is placed into an SPV that earns less volatile “utility-type” returns, the cost of capital for this component should be lower.
* Political risk mitigation – Establishing linkages between a large-scale mining operation and the local economy through open access infrastructure arrangements should avoid many of the political frustrations associated with an integrated (and exclusive) approach. Furthermore, access decisions made by an independent SPV are less likely to spark political controversy than if they are made by an integrated mine owner (which will be perceived as having a strong conflict of interest). The combination of these factors should help to mitigate the political risks typically associated with large-scale mining in SSA.
* Co-ordination of competing mining projects – In some situations, the scale and cost of mining infrastructure are so great that a single mining project cannot provide the TOP commitment required to support the entire investment. Combining or developing jointly multiple mining projects can sometimes overcome this challenge, but complex and difficult negotiations between direct competitors then become necessary. The infrastructure SPV model provides considerable scope for governments and other stakeholders to broker solutions between rival miners, and avoids protracted debate concerning ownership and control of infrastructure.
The challenges
Despite the potential advantages of the mining infrastructure SPV model, it will not be easy to implement in SSA. A number of practical challenges exist, including the following:
* Mining company scepticism – Mining companies have a strong historical and cultural preference for control and exclusive use of mining infrastructure, and may be sceptical that SPV-owned infrastructure operated on an open access basis could adequately protect their operational needs and commercial interests over the longer term.
* Regulatory gap – In all open access systems, including railway, pipeline, power and communications networks, effective regulation is critical to long-term success. An independent regulatory agency is typically established and charged with responsibility for making (or reviewing) decisions concerning access, tariffs and compliance with network rules. In the context of SSA, major mining companies and lenders to an infrastructure SPV (among others) will not be comfortable with a regulator that is established and overseen by the host country’s government. Significant work is required to identify or create international institutions capable of providing appropriate regulatory oversight.
* Cross-border complications – A number of SSA’s world-class mineral deposits are located in landlocked countries, or where the most obvious route to the sea runs through a neighbouring country. Rational development of mining infrastructure in these situations often requires effective inter-governmental co-operation. Such co-operation has been relatively limited in SSA to-date, although the recent accord between Mozambique and Malawi to facilitate the Nacala Corridor is encouraging.
* Availability of infrastructure capital – Globally, a plethora of specialised infrastructure funds are seeking opportunities to invest capital in projects that can provide stable long-term returns. There has been an unexpected shortage of such projects in OECD countries, as governments struggle to keep post-crisis public deficits under control. It remains to be seen whether, in the current environment, these funds would be willing to deploy capital into well-structured SSA mining infrastructure projects despite the unavoidable political risks involved.