Feb 2, 2012 3
Who actually benefits from mining? Deloitte examines the question from a high level value creation point of view
For more information or a detaled discussion on the subject, contact Abrie Olivier (Mining Industry Leader) at email@example.com or +27 (0)82 874 6040 and Jacek Guzek (Associate Director) at firstname.lastname@example.org or +27 (0)82 940 6896.
Who actually benefits from mining?
Although the tide of resource nationalism has risen globally, with countries from Africa to Australia, Brazil, Canada, Chile and India considering options to increase state interventions in the mining sector, nowhere is the debate as high-profile, emotionally charged, divisive and potentially damaging as in South Africa.
The country is admittedly sitting on a mineral treasure trove second to none: 52 commodities reside under its surface, including the world’s largest reserves of platinum, manganese, chrome, vanadium and gold, and major reserves of coal, iron ore, zirconium and titanium minerals – all at an estimated in-situ value of $2,5 trillion1. It is evident that the South African mining and minerals sector has immense value generation potential.
But in spite of its mineral (and other) riches, the country has been criticised for being seemingly slow in addressing what Mineral Resources Minister, Susan Shabangu, called South Africa’s “evil triplets”, namely: poverty, inequality and unemployment. Against this context, the proponents of a radical state intervention into the South African mining industry assert that the mineral wealth of the country ends up in the pockets of “monopoly capital” rather than benefiting its population at large. Who actually benefits from mining, they ask, and is it at the expense of those who truly should be benefitting? Let’s examine the question simply from the high-level value creation (or destruction) point of view.
Each (not only) mining opportunity has an inherent, or “in-situ”, value, which could eventually end up in the pockets of enterprising investors, if not for various concessions necessary to convert it into a commercial value all along the life-cycle of the project. These concessions, at a very high level, could include: R&D capital, investment capital, operating costs (including salaries of employees and procurement from suppliers), time value of money, royalties and taxes, etc. (refer to figure 1 below).
In the end, only a small residual portion of the inherent value of an opportunity finds its way to original private shareholders. In our experience, there are many successful mining projects where this residual value is only a lower single-digit percentage of the primary in-situ value. The remainder, in fact the lion share of the inherent value of any commercial opportunity, ends up in the economy at large, either through state treasury or through private sector spending, where it benefits all and translates into wealth and jobs.
Citigroup Global Markets2 estimates that “only 7% of the value generated by SA miners gets distributed to shareholders i.e. the entrepreneur and risk taker. The biggest beneficiaries are in fact suppliers to the industry, mining sector employees and the government. To turn opportunity into this value (and many fail along the way) requires substantial upfront investment capital and specialised and scarce skills.
Figure 1: In-situ value graph
The question remains, why would government want to assume full risk of a complex entrepreneurial activity for such an incremental value, given the significant investment requirement?
In spite of some notable exceptions, governments’ track record in managing commercial entities the world over is, at best, inconsistent3. One can therefore question what value will ultimately accrue to society by replacing the role of the entrepreneur with a government institution. Transferring ownership from private shareholders to the state, to ensure “fair” distribution of generated value, creates a different set of incentives for public sector entities, potentially resulting in consequences contradictory to the primary intentions. While maximising shareholder value is what drives the management of private companies, the definition of objectives for a state principal is a lot more complex and politically charged. Alternatives such as financial sustainability, job creation, fair distribution, or community development often require trade-offs between efficiency and policy imperatives, blurring the overall mandate. In addition, performance of managers in the public sector companies is not always subject to the same level of scrutiny as is standard in the private sector. Furthermore, public firms do not face take-overs or bankruptcy, with all their threatening but performance-enforcing consequences.
On the other hand, for a relatively small reward or incentive, private investors shoulder the entire burden of risk in developing and managing complex opportunities. They are also usually willing to wait for returns throughout volatile economic and commodity
cycles. But any entrepreneur has to be assured that this risk is worth taking, considering the alternatives to deploy their capital in the most productive manner, and the security of tenure is the very basic consideration.
It therefore appears that the intensity and profile of the debate on nationalising the mining industry in South Africa is far out of proportion with respect to the actual value that its resolution is capable of generating or redistributing.
Rhodes University economists, Gavin Keeton and Greg White, estimated in 20104 that had the nationalization of the South African mining industry been carried out then, the bill to the government would be around R850bn (i.e. the market value of listed SA mines).
If the government were to borrow this sum at the current interest rates, annual interest payments would amount to R72bn, almost 8% of total state spending. Even if state ownership had been limited to 51% and nationalisation without compensation was considered, the interest payments would still be close to R20bn, as foreign owners of SA mining assets would have to be compensated based on international and
bilateral investment treaties. In return, the government would gain some R20bn of extra after-tax profits of nationalised companies belonging to the state. Claims that nationalisation will enhance the state’s “fiscal capacity” are therefore false.
“It therefore appears that the intensity and profile of the debate on nationalising the mining industry in South Africa is far out of proportion with respect to the actual value that its resolution is capable of generating or redistributing”
Historically, metals and mineral resources seem to have been the favourite nationalisation targets – especially at the peak of commodity cycles when windfall profits have been evident. Only the banking sector can be said to have been targeted for nationalisation with similar resolve. What is conveniently forgotten is that the global mining industry goes through alternating cycles of poor- and super-profitability, and a steady stream of positive free cash flows is not guaranteed.
The South African mining industry, although neither the biggest contributor to domestic product nor the largest employer, cannot be underestimated in terms of its importance to national economy or, indeed, to national identity. It is only natural that a society with the South African level of inequality, debates the best use of its resources. However, the focus of such a debate should rather
shift from re-distribution of relatively insignificant residual value to identifying and removing impediments to growth of the mining industry, which has the potential to generate far greater wealth than is presently the case. More so, considering that efficiency, diversity, and the competitiveness of the mining sector are not questionable.
In the words of the State President, Jacob Zuma: “The state prepares the environment for economic growth and provides support to the private sector by providing enablers and removing obstacles” (a speech prepared for delivery at the World Economic Forum in Davos, Switzerland, January 2012). In such an environment both the state and the private mining sector have at their disposal multiple instruments and tools to optimize components of the industry value graph, which can forward the developmental agenda of the government as well as accommodate just rewards for entrepreneurial risk. Exactly who benefits from mining is as important a question as who would lose on its nationalisation.
For more information, please contact Abrie Olivier (Mining Industry Leader) at email@example.com or +27 (0)82 874 6040 and Jacek Guzek (Associate Director) at firstname.lastname@example.org or +27 (0)82 940 6896
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1. Chamber of Mines, Facts & Figures 2010
2. Nationalisation – killing the goose that lays golden eggs, 29 June 2011
3.“The return of state-owned enterprise: should we be afraid?”, A. Musacchio and F Flores-Macias, Harvard International Review, 31/07/2009
4. Nationalising the mines will be an expensive business, Business Day, 20/09/2010