Guest post: frontier markets up the ante on political risk in mining
Mining companies have been busy scouring investment frontiers that they once avoided. The world’s seven largest gold-producing companies are all developing major projects in frontier markets, including Papua New Guinea, Kyrgyzstan, Mauritania, and Ecuador.
Geologically-attractive deposits (especially for gold, and to a lesser extent, copper) in politically-stable countries are scarce today, while large, untapped deposits in frontier markets offer greater promise. However, this shifts risks from below- to above-ground. The world should brace itself for an increase in supply disruptions for key commodities.
With Chinese demand for commodities set to remain strong – even if not unrelenting – mining companies are willing to take on a higher degree of political risk to take advantage. As a result, above-ground risks are quickly gaining equal footing to traditional geological and engineering considerations for mining projects.
Frontier markets are characterised by the absence of strong political institutions and a paucity of earlier major natural resources investment. Compared to the Bric nations and more established emerging markets, the frontier nations are generally beset by more severe poverty and deeper social cleavages, through ethnic, regional, or sectarian disputes.
The new trend toward frontier markets will have several implications for mining companies and metals markets. The lack of a track record for resource investments makes the rules of the game less clearly defined and more open to erratic changes and politicisation.
An example is the 2009 mining contract review in the Democratic Republic of Congo (DRC) by the government that recently led to sale by First Quantum of all its DRC assets, after the government revoked its mining rights to the Kolwezi project. The assets were sold for $1.25bn, well below analyst valuations of around $2.5bn before the government took control.
Weak rule of law will exacerbate such risks, as will a propensity on the part of host governments to partner with Chinese and other state capitalist partners under opaque terms (as evidenced by China’s $6bn infrastructure loan to the DRC for mining assets).
Until communities see tangible benefits to mine development – which can take years to come about – local opposition for social and environmental reasons is likely, due to chronic lack of development. The inability of the Ricardo Martinelli government in Panama to pass a new investor-friendly mining law is a perfect example of this phenomenon. The law was stimied due to massive protests by indigenous groups over fears the government would begin issuing licenses to develop the massive Cerro Colorado copper deposit (which the government estimates to contain 25 billion pounds of copper) in a semi-autonomous indigenous area.
Local opposition can even turn violent, as it has for African Barrick Gold at its North Mara gold mining operations in Tanzania, where sporadic raids by local populations since tensions flared in 2008 have led to several deaths and prompted the company to build a security wall around the site.
Finally, multi-billion dollar minerals investments can have a profound impact on the economy of a frontier market host nation. Ivanhoe’s $5bn gold/copper Oyu Tolgoi project is expected to account for around a third of Mongolia’s GDP, while Toronto-based Kinross spent $1bn in 2011 on a major expansion of its Tasiast gold mine (expected to be completed by 2014), which equals around a quarter of Mauritania’s GDP for that year. While this dependence can be advantageous in terms of giving a project “VIP” status in the eyes of the host government, it often also creates risk as the economic contributions from taxes, royalties, and local purchasing become a driver for political conflict.
Yet none of these above-ground risks appears to be meaningfully dissuading mining companies from pouring billions of dollars into new mine development in frontier markets, where despite a political risk premium attractive resources continue to draw attention.
Gold’s shift toward frontier markets is explained by the slow growth of gold production over the last decade; projects in more stable areas are harder to find, and those that exist often face significant environmental challenges. From 2001 to 2010, global mined gold production grew from 2,646 tonnes to just 2,696 tonnes. While this meagre pace partly reflects the side effects of underinvestment in exploration during the low gold-price cycle of the 1990s, it also reflects the longer lead times associated with the frontier markets that are now essential to growing global supply. In fact, three of the world’s ten largest gold mines are located in frontier markets: Uzbekistan (Muruntau, owned the government), PNG (Lihir, owned by Newcrest Mining), and Mongolia (Oyu Tolgoi).
Frontier markets have become increasingly important to other minerals markets, too. The DRC and Mongolia are emerging copper giants, while Mozambique and Mongolia will shift the production profile for global coal markets. Guinea, Liberia, and Sierra Leone, meanwhile, are set to become important sources of iron ore production.
The new reality will be a greater risk of supply disruptions and a higher political risk premium in metals markets.
Robert Johnston is director, global energy and natural resources, at Eurasia Group, and Divya Reddy, is an analyst, global energy and natural resources, also at Eurasia Group.
Geologically-attractive deposits (especially for gold, and to a lesser extent, copper) in politically-stable countries are scarce today, while large, untapped deposits in frontier markets offer greater promise. However, this shifts risks from below- to above-ground. The world should brace itself for an increase in supply disruptions for key commodities.
With Chinese demand for commodities set to remain strong – even if not unrelenting – mining companies are willing to take on a higher degree of political risk to take advantage. As a result, above-ground risks are quickly gaining equal footing to traditional geological and engineering considerations for mining projects.
Frontier markets are characterised by the absence of strong political institutions and a paucity of earlier major natural resources investment. Compared to the Bric nations and more established emerging markets, the frontier nations are generally beset by more severe poverty and deeper social cleavages, through ethnic, regional, or sectarian disputes.
The new trend toward frontier markets will have several implications for mining companies and metals markets. The lack of a track record for resource investments makes the rules of the game less clearly defined and more open to erratic changes and politicisation.
An example is the 2009 mining contract review in the Democratic Republic of Congo (DRC) by the government that recently led to sale by First Quantum of all its DRC assets, after the government revoked its mining rights to the Kolwezi project. The assets were sold for $1.25bn, well below analyst valuations of around $2.5bn before the government took control.
Weak rule of law will exacerbate such risks, as will a propensity on the part of host governments to partner with Chinese and other state capitalist partners under opaque terms (as evidenced by China’s $6bn infrastructure loan to the DRC for mining assets).
Until communities see tangible benefits to mine development – which can take years to come about – local opposition for social and environmental reasons is likely, due to chronic lack of development. The inability of the Ricardo Martinelli government in Panama to pass a new investor-friendly mining law is a perfect example of this phenomenon. The law was stimied due to massive protests by indigenous groups over fears the government would begin issuing licenses to develop the massive Cerro Colorado copper deposit (which the government estimates to contain 25 billion pounds of copper) in a semi-autonomous indigenous area.
Local opposition can even turn violent, as it has for African Barrick Gold at its North Mara gold mining operations in Tanzania, where sporadic raids by local populations since tensions flared in 2008 have led to several deaths and prompted the company to build a security wall around the site.
Finally, multi-billion dollar minerals investments can have a profound impact on the economy of a frontier market host nation. Ivanhoe’s $5bn gold/copper Oyu Tolgoi project is expected to account for around a third of Mongolia’s GDP, while Toronto-based Kinross spent $1bn in 2011 on a major expansion of its Tasiast gold mine (expected to be completed by 2014), which equals around a quarter of Mauritania’s GDP for that year. While this dependence can be advantageous in terms of giving a project “VIP” status in the eyes of the host government, it often also creates risk as the economic contributions from taxes, royalties, and local purchasing become a driver for political conflict.
Yet none of these above-ground risks appears to be meaningfully dissuading mining companies from pouring billions of dollars into new mine development in frontier markets, where despite a political risk premium attractive resources continue to draw attention.
Gold’s shift toward frontier markets is explained by the slow growth of gold production over the last decade; projects in more stable areas are harder to find, and those that exist often face significant environmental challenges. From 2001 to 2010, global mined gold production grew from 2,646 tonnes to just 2,696 tonnes. While this meagre pace partly reflects the side effects of underinvestment in exploration during the low gold-price cycle of the 1990s, it also reflects the longer lead times associated with the frontier markets that are now essential to growing global supply. In fact, three of the world’s ten largest gold mines are located in frontier markets: Uzbekistan (Muruntau, owned the government), PNG (Lihir, owned by Newcrest Mining), and Mongolia (Oyu Tolgoi).
Frontier markets have become increasingly important to other minerals markets, too. The DRC and Mongolia are emerging copper giants, while Mozambique and Mongolia will shift the production profile for global coal markets. Guinea, Liberia, and Sierra Leone, meanwhile, are set to become important sources of iron ore production.
The new reality will be a greater risk of supply disruptions and a higher political risk premium in metals markets.
Robert Johnston is director, global energy and natural resources, at Eurasia Group, and Divya Reddy, is an analyst, global energy and natural resources, also at Eurasia Group.
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