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Of cabbages and kings
David McKay
Posted: Tue, 21 Oct 2008
[miningmx.com] -- THE RULING THEORY is that it’s getting easier to invest in Africa. There are less conflicts and more democracies than before – 34 to be exact – and the demand for commodities has made mining firms not only more desirous of investing in Africa but willing to raise their risk tolerance to do so.
But Africa is still no bed of roses.
Politics remains volatile, there’s a constant deficit in adequate infrastructure and the regulatory environment is changeable.
In some of those respects the recent events in Zimbabwe make it the poster child. But there are other examples where politics are still tenuous, such as Kenya’s power-sharing deal struck earlier this year that saw presidential hopeful Raila Odinga take up the Prime Ministership while rival Mwai Kibaki remained President.
Investors are also vulnerable to massive policy disruptions when heads of
state die in office. Zambian president Levy Mwanawasa died in August and could be succeeded by Michael Sata, who during his election run-off with Mwanawasa, was hostile to foreign investment. (In September, Sata staged a turnaround, telling Reuters he’d welcome Chinese investors into the country’s mining industry if elected president. That policy shift is perhaps too obviously designed to reassure investors overseas.)
In Nigeria, there’s speculation the President, Umaru Musa Yar’Adua, underwent a kidney transplant in Saudi Arabia and may yet have to resign from office – speculation that’s since been denied without fully explaining the President’s absence.
Returning to Zimbabwe, its uneasy power-sharing entente – the details of which had yet to emerge at the time of writing – could see Robert Mugabe remain President until he dies.
And lest we overlook political realities in SA there will be a change in the African National Congress’s leadership next year (at the latest), which may be accompanied by other possible, potentially leftist, policy changes.
Commenting broadly on Africa’s political prospects, Martyn Davies, CEO of Frontier Advisory, a company that provides strategic advice to investors, says the “tripod of stability” in Africa – Nigeria, Kenya and SA – has been upset lately. But he doesn’t see evidence the flow of investment in
Africa will lessen. “They have to play by the rules of Africa or leave. And nobody’s leaving,” Davies says.
That’s despite some pretty major shocks. Remember the militia in the Congo that commandeered vehicles owned by Anvil Mining they later used to transport them to villages where atrocities occurred? Or in the case of AngloGold Ashanti, where employees were effectively pressurised into paying protection money.
More recently, Rio Tinto has been embroiled in a dispute to keep control of its US$6bn Simandou iron ore mine, the ownership of which has been questioned by Guinea’s government. If Rio Tinto is allowed to develop the mine 10 000 jobs will be generated. That can’t come soon enough, because on 7 September a mob attacked Rio Tinto vehicles near Simandou, setting them alight in protest jobs hadn’t been created.
Yet external political will to develop Africa continues unabated. The Industrial Development Corporation (IDC), which is owned by SA’s
Government, says there are few “no go” areas in Africa. “Stability in the country of investment is obviously important, but the country doesn’t have to be perfect,” says Ufikile Khumalo, the IDC’s divisional executive for resources. “We go in with our eyes open – but we go to invest as well,” he says of the IDC’s remit to bring development as well as financial returns.
In any event, the IDC plays a counter-cyclical game: taking long-term investments exactly at a time when the continent’s people most need it, which is normally during times of distress. “We’ve definitely moved forward,” says Khumalo. “Especially from a developmental point of view.”
Khumalo is one of several businessmen who think the recent change in Zimbabwe represents opportunity. “I was in Zimbabwe and we (IDC) are considering investments there. Given the IDC views itself as a long-term investor it’s quite possible we might make an investment in Zimbabwe.”
Predictably, SA’s publicly
listed banks don’t quite agree on Zimbabwe. Brad Breetzke, head of project finance at Standard Bank, says: “The bank wouldn’t have much appetite for Zimbabwe. Even if we could get our heads around the reputational risks we wouldn’t go.”
Part of the problem is that it’s impossible to obtain political risk cover for such places. The Export Credit Insurance Company of SA – known as Ecicsa and Government-owned to boot – wouldn’t offer it, he says. “Up until now Zimbabwe was a no-go area,” says Dharmesh Kalyan, head of Investec’s commodities and resources finance. “The view is very much a wait-and-see. But even though we’re not looking to finance anything there we’ve been approached by quite a few parties.”
Nonetheless, the sheer allure of Zimbabwe’s minerals wealth must become attractive over the long term. It has diamonds and (to a lesser extent) gold. But a major and relatively untapped resource is coal – especially coking coal. In fact, there’s even speculation SA mining entrepreneur Lazarus Zim is weighing up investing in Zimbabwe’s coal.
Of course, Zimbabwe’s major drawcard is its platinum, in which SA’s Impala Platinum is a major investor, along with Anglo Platinum and Aquarius Platinum. More than 50% of Impala’s total platinum reserves are located in Zimbabwe, even after a deal with its government in which it swapped platinum reserves for “points”
that help it meet so-called “indigenisation legislation” – which may have been passed by the government.
Says Impala Platinum CEO David Brown of the company’s position: “About 8% of our overall production comes from Zimbabwe. But that’s not our vision. We have much grander plans – yet the climate means we can’t invest at present.”
One of the major difficulties is retaining skills there. Impala tackles that by protecting its employees from the economy and lifestyle risks as much as possible. In practice, that means providing transport, importing fuel and food for employees and minimising their interaction with the economy. There’s also a large proportion of local management, says Brown.
Its grander plans include deriving about 1m ounces of platinum from Zimbabwe. Meanwhile, Impala says it’s planning for a status quo in Zimbabwe’s politics for the next six to 12 months.
There are some real current problems to tackle in the country. One is whether
indigenisation legislation – effectively, black economic empowerment – is likely to stick. It’s not fully known whether black empowerment in Zimbabwe is law or not.
One aspect of that law is for companies to part with 51% of equity.
“We don’t think that’s right,” says Brown. In effect, it means mining firms that have funded development of the mine, and have bulked the resource, lose control of the asset but have to continue operating it.
Brown says indigenisation isn’t a bad thing. “I’m in favour of it in principle.” He just thinks having government or government-approved companies owning 51% of an asset they didn’t develop is a poor risk:reward model for the developer.
Roelof Horne, portfolio manager of the Investec Africa Fund at Investec Asset Management, says the reversal of some laws is exactly what Zimbabwe needs. “Stopping hyperinflation and rebuilding GDP needs a half to deficit funding by the printing press?? and a speedy and complete reversal
of economically inhibiting and distorting laws and regulations,” says Horne.
“There are some tough decisions to be made and implemented. If they’re not nobody should hope for a magical reversal of the economic tragedy that’s Zimbabwe.”
The IDC’s Khumalo agrees there are problems in Zimbabwe beyond just the political, such as exchange controls – which make it impossible for investors to take money out of the country.
So much will turn on how the power-sharing pans out between Morgan Tsvangirai’s Movement for Democratic Change and Mugabe’s Zanu (PF). “It’s moving towards the positive in Zimbabwe,” says Khumalo. “The trend is notably irreversible.”
Never mind political changes in Zimbabwe, Zambia (following the death of Mwanawasa) and Angola (MPLA re-elected but needs to deliver) there’s inescapable change in SA, the largest contributor to the continent’s GDP.
Says Khumalo: “I don’t see anything new leadership would ask us to do that we aren’t
already preparing for. Our strategy is two-fold: to increase industrial capacity and to encourage entrepreneurship. We don’t see that changing and, in fact, we see ourselves investing more. Anyway, we’re very adaptable to change.”
Commenting on infrastructural limitations in SA, such as its power and transport capacity problems, Khumalo says the IDC could invest in both. Power rationing earlier this year by Eskom, amid falling coal supplies and spiralling consumption, had an obvious negative impact on investment perceptions, not to mention the possibility new capital projects would be hampered.
“We’ll be supporting Eskom’s growth,” says Khumalo. “But remember that power has no boundaries, so we’re looking at other projects, such as Inga.” In fact, Khumalo was due to leave for the Congo days after the interview.
Inga 3 is a massive expansion of a hydroelectric power programme using the waters of the Inga River that courses through the Congo. It could provide massive power capacity to Africa, including SA. Refurbishment of the existing Inga 1 and 2 will provide regional power supply stability.
“We’re getting an update on Inga shortly,” says Khumalo. “There’s a lot of interest and hope that Inga 3 will find its way into SA’s [power] grid.”
Khumalo says the IDC is “also engaging” with Transnet in developing freight capacity,
particularly from SA’s coal and iron ore mines to the coast. “We want to see rolling stock capacity improved, whereas more rail capacity is a longer-term project,” says Khumalo.
From a regulatory risk viewpoint there are additional problems in SA. One is that leftist policies introduced on the back of a successful Jacob Zuma presidential election could result in critical changes to SA’s already controversial Mining Charter.
Such a review of the charter has already been planned for next year by the current Government when mining legislation was first promulgated. The talk is that mineral rights will be cast into a Government-controlled mining company to be financed by proceeds of another piece of controversial legislation – the Royalties Bill – due to be enforced next year.
Nonetheless, as far as commodities-related banking goes Investec prefers to ply the majority of its business in SA. “In terms of line of sight we’re choosing to do deals in SA because
the opportunities are here,” says Kalyan.
Apart from the prospect of refinancing empowerment deals, Investec is also identifying junior mining firms “at the bottom end of the cost curve, with strong management and high grade resources”.
Changes to regulations cause major stress for mining companies. The Zambian government’s decision to first lift royalties on revenue and then impose a windfall profit tax should metal prices push through a certain trigger price help only damage investor confidence. From the state’s point of view, it recognises commodity price increases and wants to share in the market, not be exploited.
“The effects of these things can be devastating,” says Breetzke. “What it means is that a mine with a 35-year life becomes an eight-year life because the mining company only mines out the high-grade areas.”
However, Davies maintains the prospects for Africa remain good. “Africa GDP growth was about 6,8% last year,” he says. “But
it could top 7% – notwithstanding the financial crisis.” He also believes the notion of “developing or emerging markets” could become obsolete. “Let’s think about Africa in terms of frontier markets – less established, post-conflict economies.”
Perhaps it’s a fly in the ointment, but the sudden correction in the commodities markets is providing a slight complication: a new overlay to the risk of investing in Africa.
Now around four months old, the commodity correction has been amplified by significant distress in global financial markets, which has seen investors selling all valuable assets for cash, including metals. That’s making raising US dollars in Africa more difficult to achieve.
Against developments such as this managing risk is a major challenge. From a banking perspective there are a number of sources of political risk cover, including commercial entities, such as a Lloyds Bank syndicate through to organisations such as the Multi-lateral
Investment Guarantee Agency, an arm of the World Bank.
Perhaps the best way of achieving political risk insurance is through Ecicsa, which is available if more than half of the equipment used in a project is sourced from SA. It often is.
The project developer then pays a relatively competitive 125 points above London Interbank Offered Rate, the lending rate at which banks borrow from one another. Expropriation of properties, inconvertibility of funds and other political and commercial risks are normally then covered (85% of commercial risk covered, to be exact).
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