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Challenges for Governments Seeking to Get Most Out of Natural Resources

Grasberg mine in Indonesia (Photo credit: Paul Q. Warren)
Grasberg mine in Indonesia (Photo credit: Paul Q. Warren)

By Nora Mardirossian

On March 2, 2017, Tanzania banned all exports of unprocessed gold and copper concentrates. The measure was taken in order to force companies to set up in-country processing of raw materials, with hopes of fostering the development of a smelter in the country. Since the ban was announced, the government has accused Acacia Mining, which owns large gold and copper extraction projects in the country and a large portion of which is owned by Canadian mining giant Barrick Gold, of undervaluing the concentrates in its shipments abroad. Subsequently, the government accused the company of operating illegally and evading taxes. Acacia has denied all of these accusations. Nevertheless, the company’s stock prices have taken a dive. Acacia claims to be losing $1 million per day as a result of the ban and fears it will have to shut down one of its mines, which it claims would cost the company $30 million. Instability regarding the company’s operations in Tanzania has influenced share prices and commodity prices across the market. Acacia is currently in negotiations with the government and is considering the option of building a smelter to process minerals in Tanzania.

In 2009, Indonesia passed the Law on Mineral and Coal Mining No. 4 that requires mining companies operating under certain contracts to process raw materials within the country before exporting them to other markets. When the law was finally enacted in January 2014, American mining company Freeport McMoRan, which owns Grasberg, one of the world’s largest mines, was then required under the law to build a smelter to process copper, rather than exporting the raw product to China. Such a smelter is estimated to cost over $2 billion. Indonesia and Freeport are still negotiating an agreement on the terms of the company’s mining license. In August 2014, exports of copper concentrate resumed, though they are subject to a new export levy. To stimulate the development of in-country processing facilities, the government has provided lower export levies for mining companies that are willing to commit to developing processing and refining facilities.

Other resource-rich developing countries such as South Africa, the Philippines, Kenya and Zambia have undertaken similar efforts to encourage local value added activities, or beneficiation. Beneficiation refers to the processes that improve the value of ore by removing gangue, or commercially worthless materials, which results in a higher grade product. Policies that promote local beneficiation aim to have this processing occur in the country from which they have been extracted so that more of the benefit from the mining industry remains localized.

In 2015, Pricewaterhouse Coopers recognized the trend of governments looking to maximize returns from their national resources through various strategies aimed at securing a greater share of the value from mining operations. This is most commonly done by requiring in-country beneficiation prior to export, imposing export restrictions, or increasing export levies on unrefined ores. Such policies are adopted to help develop the downstream industries that add value to resources, such as smelting and refining, and allow the country to have access to another share of the profits from the refined metals. After being transformed into higher value products in-country, these resources can then be exported, or consumed locally without the extra step of being exported for processing at a loss to the country of origin. Governments can thus extract benefits from mining activities beyond the traditional exchange for taxes and royalties.

These changes in policy can be characterized as a reaction to the history of bad mining deals that have plagued resource-rich developing countries. Transnational mining corporations entering into contracts with companies often have more expertise and access to better legal representation, giving them the upper hand in bargaining with governments. These corporations often prefer to send raw resources abroad to a central processing facility and dispose of in-country processing to reduce costs if it is deemed a non-core activity. Trade liberalization policies have allowed this practice to perpetuate, meaning that most minerals extracted in Africa, for example, are exported with minimal processing. Without significant value added processing in the country of origin, the vast majority of the minerals’ value is earned abroad.

Disappointed with the less lucrative results of these policies than expected and in light of the heavy environmental and social costs of mining, in recent decades a number of developing countries have pursued targeted policy interventions that promote protectionism or resource nationalism.

For example, Botswana’s economy has been heavily dependent on mining diamonds since the 1980s, so in an effort to increase employment and develop a manufacturing and trade sector, the government adopted a beneficiation policy. The effort aimed to establish a local diamond cutting and polishing industry. In 2005, the government reached an agreement with De Beers which allowed the nation to become a locale for diamond sighting, sales and distribution. This turned the century-old practice of extracting diamonds in Africa and aggregating them in London on its head, as roughly 15 percent of the diamonds from Botswana are cut and polished in the capital and diamond buyers now flock there to view De Beers’ rough gems sourced from around the world. Botswana’s economy has grown at an average rate of 7 percent over the past 20 years.

Some see this as a necessary step for countries that have suffered under bad trade and investment deals in the past, particularly in Africa. In the 2013 Africa Progress Report, former UN Secretary-General Kofi Annan said, “processing natural resources before exporting them brings extra value” and that “Africa cannot build dynamic growth and shared prosperity while extractive projects operate within enclaves or countries export natural resources unprocessed.” The United Nations’ Africa Mining Vision, which aims for broad-based sustainable growth and socio-economic development, promotes local value added processing of minerals to create opportunities for local participation.

However, investors note the substantial impact the introduction of beneficiation policies can have on commodity prices. For example, announcements of changes in the Indonesian treatment of the Grasberg mine were directly followed by significant changes in global copper prices. Additionally, share prices for Acacia, whose business relies on mining in Tanzania, have taken considerable hits following the government’s accusations of illicit activity. Investors anticipate that more resource-rich developing countries will take similar steps in coming years, especially if commodity prices swing back up after years of stagnation.

In developing policies that encourage value added processing, governments have a number of factors to consider. The most notable benefits include developing local enterprise and creating jobs, in particular more highly skilled jobs.

As Humphreys, Sachs, and Stiglitz point out, economies reliant on nonrenewable natural resource extraction share the challenge that extraction can take place independently of other economic processes in the country. Without linkages to other industrial sectors, the growth of extraction does not stimulate other sectors of the economy nor create a great number of jobs. Value added activities can add those links to manufacturing sectors, thus diversifying the economy.

Value added activities can also encourage the development of a more skilled workforce. When a country develops natural resource extraction as a major industry, it will not necessarily invest in a skilled workforce since mining does not require it. However, developing downstream activities can encourage a country to invest more in the training of its own workers, which can not only improve the quality of jobs for those workers, but also the quality of education in the country as a whole.

Pouring extracted gold during the smelting process (Photo Credit: Khushie Singh)
Pouring extracted gold during the smelting process (Photo credit: Khushie Singh)

The revenues from value added activities could be used for the public good, including compensation for the adverse socio-economic and environmental impacts of extractive activities on local communities and vulnerable groups. One common criticism of protectionist measures such as these is the allegation that they either result from or enable corruption. Resource-rich countries often suffer from government corruption. In fact, a report from the ONE campaign found that developing countries lose $1 trillion each year due to corrupt or illegal cross-border deals.

Countries with large endowments of natural resources often struggle in terms of economic development and good governance. Economists have posited a number of explanations for this phenomenon, called the “resource curse.” Often, companies and politicians are incentivized to use political mechanisms to capture the rents, or gaps between the value of a resource and the costs of extracting it. Corruption frequently follows this behavior. In fact, an IMF study from 1999 showed that natural resource dependence is a strong predictor of corruption.

Policies that encourage value added activities might enable corruption because the increased number of transactions in which money changes hands can provide more opportunities for corrupt officials and intermediaries to siphon off money from illicit activities or collect bribes from companies. Corruption, misallocation of resources and inefficiencies are serious challenges many resource-rich countries face. However, keeping the profits of extractive projects local can also pose an opportunity to allow countries that have historically been subject to unfair trade policies and extractive contracts to address urgent needs for resources vital to citizens’ livelihoods, economic activity and development. Governments of these nations gaining more control of their resources certainly will not single-handedly solve all problems, however, it may be a step towards ensuring the people reap more of the benefits of the extraction of their resources and thus should not completely be discounted due to concerns regarding corruption.

Aside from internal management of the revenues from value added activities, there is an array of additional challenges in adopting policies that encourage value added activity. First, establishing refineries and smelters in-country, if they do not already exist, can be extremely costly.

Value added activities have high entry barriers because processing minerals can require significant upfront investments. Smelting of mineral concentrates is an energy intensive endeavor that can require investments in electricity infrastructure, along with other technologies. Power shortages and rising electricity prices may be challenges. The construction of roads and rail many also be necessary for transportation. Furthermore, downstream operations can require high inputs of water, which may be scarce depending on the locale. These resources may have to be diverted from other projects and communities.

Because developing downstream facilities can take years, there is an opportunity cost of the lost revenues and resources in the meantime. Any subsidies or favorable tax treatment for companies that comply with policies that promote value added activities also represent a loss of resources that could otherwise be used to fund urgently-needed poverty reduction projects, for example. Governments will need to plan for this as they build infrastructure. In addition, they will likely need to invest in training programs to develop skilled labor to operate the facilities to ensure that downstream activities are not exported to countries with more skilled workforces nor are skilled workers brought in from abroad.

Because of these major upfront investments, for downstream operations to be economically viable, they often require economies of scale, or a high enough volume of minerals extracted, to justify the fixed costs of developing the necessary infrastructure. The economic viability of developing value added operations can depend on the specific minerals being processed. If the commodity draws significant local demand, has high transport costs and/or has lower capital intensity, developing downstream operations is more likely to be profitable.

For example, copper plants require a higher volume to be profitable, which has posed a challenge in Tanzania where the amount currently produced would not generate enough for a smelter to be profitable. Thus, strictly requiring a company to construct a smelter without discovering additional copper reserves or importing them from abroad could drive Acacia to abandon its operations in the country entirely. On the other hand, the significant export value added to nickel by smelting and refining it makes such operations more profitable. While Indonesia’s export ban has failed to work to the nation’s benefit for copper because the country only has one smelter that is already at capacity, the ban is expected to boost downstream producing investment in nickel. It is thus important to produce policies that target the minerals most likely to generate benefits, rather than a simple one-size-fits-all policy.

Another challenge can arise if a country invests heavily in downstream activities without making broader investments in other sectors. The volatility of mineral prices makes countries that heavily invest in value added activities especially vulnerable to fluctuations in commodity prices.

While Botswana has largely avoided the “resource curse,” as the country’s diamond sales have contributed to modern infrastructure and relatively high literacy and good governance, their promising beneficiation strategy has recently hit a snag due to the volatility of diamond prices. As the price margin between rough diamonds and polished diamonds has narrowed, cutting and polishing factories have faced closure, liquidation and downsizing. In 2015, decreased demand led to a price cut of 15 percent for rough diamonds and 8 percent for polished diamonds. If the country’s dangerous dependence on the sector continues without more diversification, price instability may bode poorly for Botswana’s economic growth.

In addition to economic barriers, there are also international trade and investment obligations that aim to restrict certain policies that shift towards increased value added activities. World Trade Organization treaties require that companies from foreign member countries are given national treatment where they operate. Taxes on unprocessed minerals and bans on exports can avoid accusations of unfair treatment if they are applied equally to domestic and foreign companies. Last year, South African President Jacob Zuma rejected a beneficiation bill due to concerns it could breach the country’s obligations under the General Agreement on Tariffs and Trade. The consequence of potential breaches could be diplomatic or legal challenges. Freeport, for example, has threatened to bring a claim against Indonesia in front of an international arbitration body alleging Indonesia breached the company’s 30-year mining contract by requiring in-country processing because the 2009 law halted operations at Grasberg mine.

The movement towards increased beneficiation will be interesting to follow as it poses opportunities and challenges for managing wealth extracted through mining in resource-rich developing nations. The high-stakes and highly-publicized examples of Indonesia and Tanzania will be good to watch.

A major concern for nations considering encouraging value added activities is how to do so without discouraging the investment they desire. Drafting clear policies and implementing and enforcing them predictably can help a government avoid deterring foreign investors by developing the reputation of an unstable policy environment. Thus, policies such as Indonesia’s lowering of export levies for mining companies that are willing to commit to developing processing and refining facilities have the potential to stimulate in-country processing without scaring away investors.

While banning exports of raw materials and requiring companies to process in-country may seem like an extreme measure, it may be a wise strategic choice to jumpstart downstream industries. In Botswana, for example, there are no such restrictions on companies, so many are increasingly exporting their rough diamonds for cutting and polishing in India, where wages are lower.

Governments must fully appreciate the complexities of beneficiation and deliberate new policies with great care. Better governance and resource distribution schemes are necessary to ensure the added revenues improve the circumstances of the people. Beneficiation is not a silver bullet that will alone achieve equitable and sustainable development, but it may be an option worth considering.

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