Taxing times for African mining

The mining sector is likely to see restructurings and write-downs as falling commodity prices and political risk hit the industry.

In 2011, the mining giant Rio Tinto paid $3.7bn for coal assets in Mozambique’s Tete province. Last year the company sold the assets on for $50m, citing the logistical challenges of moving coal the 600km from Tete to the coast.

The exuberance of the early part of the decade, when high commodity prices pushed mining companies to seek out assets in frontier African markets, has died down as prices of precious and industrial metals slide.

Rio Tinto’s disastrous experience in Mozambique is an extreme example, but the 7,000 delegates who attended this year’s Mining Indaba – Africa’s largest annual mining conference – did so against a sobering backdrop of falling earnings and rising political risk.

Before a slump in metals prices in recent months, Africa offered investors some of the world’s most attractive, untapped mineral resources.

Record high commodity prices over the last decade have helped African producers achieve some of the fastest economic growth rates in the world. Zambia grew an average of 6.4% in the last decade, largely due to a copper boom driven by demand from rapidly industrialising countries, in particular China.

Gold mining companies Randgold and Gold Fields, operating in South Africa and Ghana, cashed in as gold prices hit an all-time high of $1,900 in 2011. That proved to be the peak, however.

Fears of slowing growth in China and continuing uncertainty in developed economies have hit the outlook for industrial metals, while the US shale gas boom led to a glut of coal on international markets, pushing prices down. Gold has fallen back to below $1,250.

Slumping prices have resulted in cuts to investment, the shelving of operations and the divestment of assets – hampering growth a continent more dependent on mineral exports than any other in the world.

Political and social factors have also weighed heavily on miners.

Anglo-American Platinum saw a 50% fall in 2014 earnings following a protracted five-month labour strike in South Africa last year. The deadly Ebola virus in West Africa was the final straw for London Mining in Sierra Leone, prompting the country’s second-largest iron ore producer to go into administration. African Minerals Ltd, which also mines iron ore in the country, shut its mine in December.

Resource nationalism

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Days before the conference started, Zimbabwe’s nonagenarian president Robert Mugabe, who became chairman for the African Union in January, said, “African resources should belong to Africa and to no one else, except to those we invite as friends.

“Friends we shall have, yes, but imperialists and colonialists no more.”

An increasingly informed African public, driven by a rising middle-class, are demanding that governments squeeze more out of foreign-owned companies mining in their countries. In the face of low commodity prices, African governments across the continent are struggling to find a balance between how their raw materials are exploited – and for whose benefit – whilst ensuring that they do not scare off investors.

In Zambia, Africa’s second largest copper producer, uncertainty over taxes has rattled investors.

The copper price has plunged to a near-six-year-low, leaving production barely viable, especially for its aged mines that are costly to operate. Zambia hiked open pit mining royalties from 6% to 20% and underground royalties from 6% to 8% in January.

Higher taxes and a slump in the price of the metal to $5,663 a ton since 2013 has prompted Vedanta Resources Plc, to review its Zambian copper unit.

David Paterson, vice-president for Vedanta’s Konkola Copper Mines (KCM), told African Business on the side-lines of the conference that the additional taxes will add $85m to their cost base, at a time when the mine is in a negative cashflow.

“Raising revenue-based royalties…raises the cut-off grade for mines and all mines will no doubt close earlier than they would have otherwise than under a profit based system,” Paterson says. “In the long run…revenue-based royalties are a tax on jobs.”

Paterson said that while the company has been encouraged by early dialogue with Zambia’s new president, Edgar Lungu – other challenges remain. About $200m in historical VAT repayments are still outstanding to KCM, he says.

First Quantum Minerals Ltd and Glencore Plc are among the companies that have suspended projects valued at more than $1.5bn because of a dispute over VAT refunds, while Barrick Gold Corp, the largest copper producer in the country, blames the royalty hike for its decision to begin mothballing its Lumwana mine.

“We are paying the price for lack of foresight on the part of the industry, and perhaps … [governments] feeling the need to capture more value,” says Claude Baissac, a mining risk consultant at Eunomix. “Except it is the wrong time for everybody.”

South Africa’s lost shine

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Governments need to settle down and create stable, predictable policy environments, Baissac says – particularly in South Africa.

Over the past few years, South Africa, once the continent’s mining giant, has become increasingly marginal as it grapples with ageing mines, labour unrest and policy uncertainty.

“There are often mixed signals that come from the political establishment,” Chris Griffith, Anglo-American Platinum Ltd (Amplats) CEO, said during a panel discussion at the conference.

South Africa’s Mineral Resources Minister Ngoako Ramatlhodi told journalists on 10th February that the government would amend a law that attempts to reverse historical injustices within the mining industry. These revisions would give the state a free 20% stake in all new energy ventures and the right to buy additional shares.

Ramatlhodi said the government intended to establish a new South African mining conglomerate, “National Champion”, that could potentially buy assets sold by companies, such as Anglo American Plc.

The new company, which could focus on one or more commodities, “will be community-based with a strong worker participation and anchored and run along business principles,” he said, without going into details about how the entity would be financed.

Anglo-American plans to shed some of its underperforming assets, looking to exit from Kriel, New Denmark and New Vaal.

A five-month strike at the South African operations of the world’s biggest platinum producer last year hampered output and growth. Amplats reported a hasty slide in profits in 12 months at the end of December with $68m, down from R1.45bn ($123m) the previous year.

The platinum company is expected to offload its problematic Rustenburg and Union mines by the middle of the year, opting for shallower and more mechanised operations. Interested buyers are currently involved in a due diligence process on the mines, but Anglo may decide to list the assets as an alternative. Sibanye Gold is one of several suitors – as is the government’s National Champion project.

Coal producers that have incurred significant debt to bring mines into production are under severe strain as a result of last year’s slide in global coal prices. Junior company, Continental Coal, the Australian-listed coal producer operating in South Africa has been seeking ways out of its financial difficulties. Glencore Plc’s South African coal unit has also said that it was considering closing some of its South African operations.

“Things continue to weigh heavily on the mining sector in South Africa including the critical energy situation, adversarial labour relations resulting in extended strikes, labour productivity continues to fall,” Griffith said.

Restructuring ahead

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With risks dominating the agenda and the outlook for prices still uncertain, the industry is likely to hunker down. “This is going to be another sit-tight type of year,” one legal advisor for mining majors in Cape Town says. “Restructuring is going to dominate. Investors will be cautious.”

Africa accounted for 10% of total mining mergers and acquisitions in 2010, but Standard Bank estimates this has dropped back to about 3.5%. There were only 12 private equity deals last year in the African mining sector, with a combined value of $302m.

Mines requiring a significant amount of infrastructure investment are unlikely to get it in the current climate, mining analysts say. Exploration budgets are also going to be scaled back, according to Rajat Kohli, global head of mining and metals at Standard Bank in London.

Alan Davies, CEO of Rio Tinto, speaking on a panel at the Indaba, warned that shying away from exploration in the current slump is risky. “We are going through tough times in the industry at the moment, it is always tempting to cut back on exploration but the fundamentals are – if we do not invest in the replenishment of our resources we will go out of business.”