Mineral-rich countries should take note of today’s $4 billion write-down of Anglo American’s Minas Rio iron ore project in Brazil, which follows a $14 billion write-down of aluminum and coal assets by Rio Tinto two weeks ago and the resignation of Tom Albanese, Rio’s CEO.
Albanese, Cynthia Carroll (the head of Anglo American, who has agreed to step down in April), and several of their peers have lost their jobs at least in part as a result of their ill-fated embraces of aggressive deal-making and mega-projects in the midst of the commodities boom’s heady profits. (Other recent, scheduled and rumored departures by mining heads include Roger Agnelli of Vale, Marius Kloppers of BHP Billiton, Diego Hernandz of Codelco, Aaron Regent of Barrick Gold, Tye Burt of Kinross Gold and Richard O’Brien of Newmont Mining. While the reasons for each CEO’s ouster is of course unique, the sheer number of departures points to some common factors and challenges.) With rising costs and prices now having fallen from their peaks, many of these deals have been blamed for recent lackluster stock performance.
After a years-long spending spree driven by optimistic assumptions about the mineral markets, major mining firms are now being forced to reassess their capital allocation decisions under pressure from their shareholders to provide more efficient and rigorous capital management and more sustainable returns. Mega-projects requiring large investments in infrastructure look less appealing than projects offering attractive profitability, albeit at lower production volumes. Rio’s purchase of aluminum assets from Alcan in 2007 and of a Mozambique coal mine from Riversdale in 2011—the projects giving rise to Rio’s write-down—and Anglo American’s purchase of Minas Rio in 2007-08 were par for the course during the boom years, and the write-down of these assets is once again part of a broader trend.
While the financial press focuses on the effects these adjustments are having on stock prices, it is important not to lose sight of the fact that the changes will also negatively impact economic activity and employment in host countries. For these and other reasons, the write-downs of these assets also have important implications for countries trying to establish themselves as destinations for new mining investment.
What lessons should be drawn?
With the end of rosy projections on pricing and with less capital available, mining companies are scaling back investment and becoming more risk averse. No country is immune from this trend, though countries with a historically stable mining sector, such as Australia or Canada, offering less risky options and more predictable regulatory frameworks, should suffer less. Recent reports that Rio will favor its iron ore investments in the Pilbara (Australia) over its massive Simandou project in Guinea in the short run would seem to confirm this trend, though other factors are surely in play there, such as the proximity of the Pilbara projects to China.
Mining countries with heavy social and political challenges, like South Africa, are likely to find themselves on the losing side, as illustrated by Anglo American’s decision to close South African platinum mines employing 14,000 people. Latin America is subject to the same constraints, as exemplified by the recent suspension of Vale’s $6 billion potash mine project in Argentina.
Countries seen as new frontiers for mining investment face special challenges: they are perceived as riskier—both in terms of political risk and the sometimes massive upfront investments in infrastructure they require—which, at the margin, can make the difference between two projects with otherwise equivalent expected returns.
It is not surprising many global mining firms might well prefer to hold on to titles on promising deposits, waiting for a more favorable market environment to make substantial investments. Compounding the challenge is that many of the frontier mining jurisdictions are highly vulnerable to such stoppages: in economies heavily dependent on one or a few large mining projects, delays or cancellation will have more disastrous consequences than in bigger, more diversified economies.
These frontier economies need to take stock and make strategic choices now if they want to see the important investments in mining and infrastructure promised in times of high profitability come to fruition. The environment for policy reform is tougher than it was a few years ago. Their means and capacity are limited, their populations impatient.
What can these governments do? A troubled history cannot be changed; an aggressive communication strategy can only do so much to change perceptions. Building a solid reputation for stability takes time, but even in the short term governments can benefit from strategies aimed at reducing risk perception—not least because higher risk perception equates to lower returns for the state, all else being equal.
With fears of nationalization topping the list of miners’ concerns (ahead of labor, infrastructure and costs issues, according to Ernst & Young), governments can take steps now to further develop constructive long term partnerships with mining companies based on trust and good faith.
Following best practices in developing transparent, predictable legal frameworks, negotiating good and stable deals with investors, addressing corruption issues, and refraining from the intrusion of politics into projects under development, are good starting points. Offering overly generous incentives in an effort to attract investors is rarely a sustainable option; indeed, companies need to acknowledge that some of the deals they signed are fundamentally unbalanced and have only exacerbated the challenges they now face. While some companies have criticized government efforts to review past deals and reform exiting mining policies and legislation, systematic, nondiscriminatory, transparent reviews are sometimes necessary to make sure mining agreements, once implemented, will actually bring the expected long-term benefits to all stakeholders. This is the best guarantee of contractual stability.
In the wake of Albanese’s departure as Rio Tinto’s CEO, and with Rio Tinto re-evaluating its investments globally, countries relying on that company and other mining majors to drive development in their mining sectors—such as Mozambique, Mongolia or Guinea—will need to show their mineral potential is matched by a commitment to good governance, an understanding of the complexity of mining and infrastructure development challenges, as well as the political will to refrain from mutually disadvantageous calls for asset seizures or arbitrary expropriation.
One last thing for host governments to keep in mind: Mining is bound to remain a cyclical sector, as we cannot know definitively where things are currently. As global supplies are still adjusting to a China-led global demand, prices could still rise (and fall) in the near term. Governments that can effectively implement well-structured royalty, tax and regulatory regimes may yet benefit, and investments are more likely to eventually resume in countries that lower investor risks by implementing higher standards of governance.
Matthew Genasci is RWI Head of Legal/Economics. Thomas Lassourd is RWI Guinea Project Manager.