Environmental Impact Assessment for the proposed Aluminium Pechiney smelter within the Coega Industrial Zone, Port Elizabeth, South Africa

Transcription

1 Environmental Impact Assessment for the proposed Aluminium Pechiney smelter within the Coega Industrial Zone, Port Elizabeth, South Africa SPECIALIST STUDY: MACRO-ECONOMIC IMPACT September 2002 Prepared by J. Blignaut J and N.J. Schoeman Prepared for CSIR Environmentek Stellenbosch CSIR Report reference: ENV-S-C (B)

2 IMPORTANT CAUTIONARY NOTE: At the time of preparing the macro -economic specialist study and this chapter of the draft EIR, the financing and budgeting for the Aluminium Pechiney smelter project was still being finalised. Budgets and financial assumptions are currently still being adjusted and refined. The figures provided in this chapter must therefore be interpreted as indicative of the positive and negative macro-economic impacts. The purpose of providing these figures is largely to explain macro -economic concepts and scenarios

3 SUMMARY It is envisaged that the proposed Pechiney aluminium smelter for the Coega industrial development zone will entail a direct investm ent of R8 120 million, although the full financial cost, direct and intermediate expenditure will entail an estimated expenditure of R22 billion in 2002 prices over 26 months between 2003 and The domestic component of the direct investment is 43 per cent. The total impact on gross domestic product (GDP) for the construction is considered to be the equivalent of R3 182 million per annum or 0,25 per cent of GDP. Due to downstream and upstream economic activity one could expect that this investment activity will affect between and other workers, mostly outside the Nelson Mandela Metro area (Port Elizabeth, Uitenhage and Despatch area). This investment will mainly be financed from abroad (capital inflow), offsetting the impact that imports will have on the current account of the balance of payments. The net effect on the balance of payments is estimated to be a short-lived inflow (R6 084 million over the construction period as a whole). It is anticipated that only between 750 and 835 direct permanent jobs will be created during the operation of the plant but that an estimated jobs opportunities will be affected (created or sustained) during operation, mainly in the electricity sector, because of this investment. This implies an investment of more than R27 million per job created and provides a good indication of how capital intensive this project is compared to the economy-wide equivalent figure of R0,2 million. Pechiney expects to produce tonnes of aluminium from the plant, 95 per cent of which will be for the export market. This will generate R5 092 million per annum in 2002 prices from 2006 onwards through export earnings. In addition to the export earnings mentioned above it is expected that the value added in domestic industries will be R2 365 million per year in 2002 prices while imports are Aluminium Pechiney Coega EIA estimated at R2 296 million. This implies an expected net impact on GDP of R million per annum in 2002 prices from 2006 onwards and an expected impact of R million per annum in 2002 prices on Gross National Disposable Income (GNDI) (the difference between GDP and GDNI being the outflow of factor remittances). While exports contribute to the balance of payments, the imports and the capital outflow as a result of the repayment of the debt (estimated at R2 856 million) will put pressure on the balance of payments and the exchange rate. The total contribution to the balance of payments is therefore estimated to be -R 60 million in 2002 prices until Once all depreciation has been written off the deficit on the balance of payments will be replaced by an increase of R 560 million per annum through From 2020 onwards a surplus of R2 061 million is expected. The most appropriate financing strategy to benefi t South Africa most should be sought. Approximately 35 per cent of the total value added will, however, befall the Nelson Mandela Metro area since the main input sector (more than 57 per cent of total domestic demand) comprises of electricity which is generated elsewhere in the country. A R1 increase in domestic demand by Pechiney will lead to a total increase (direct, indirect and induced effects) of R0,68 in the Nelson Mandela Metro and R1,22 in the rest of South Africa. Also, with regard to employment the same trend is visible. For every direct job opportunity at Pechiney, 7,8 jobs will be affected locally and 14 elsewhere in the country. The Pechiney investment, though significant in absolute numbers, will have a much diluted impact on the local economy once it is in operation because of its open structure (high degree of imports and exports) and its concentrated input structure mainly electricity sourced elsewhere. Of concern is the fact that environmental externalities have not been internalised in these estimates nor has the most appropriate financing structure been sought. i

4 CONTENTS Summary...i Contents...ii List of Tables...iii Glossary...iv List of Abbreviations and Acronyms used...v 1. INTRODUCTION MACROECONOMIC AGGREGATES AND THE NATIONAL ECONOMY Macroeconomic aggregates The GEAR strategy Macroeconomic indicators APPROACH TO THE STUDY BRIEF INTRODUCTION TO INPUT-OUTPUT TABLES AND THEIR USE THE PAS2005 PROJECT: INPUT DATA AND DESCRIPTION The input data Assumptions Research method Construction phase Operation phase Structure of model IMPACT OF THE PAS2005 PROJECT ON THE SOUTH AFRICAN ECONOMY: THE RESULTS Financial impact Economy-wide impact: Construction phase Economy-wide impact: Operational phase Local economic impact: Operation phase Impact assessment Construction Operation Disclaimer CONCLUSION REFERENCES...31 Aluminium Pechiney Coega EIA ii

5 List of Appendices Annexure A: Input-Output Table and Related Technical Modelling Issues...32 Annexure B: Breakdown of Input Data: Construction: Total over Three Years...46 Annexure C: Discounted net Present Value: Construction: Prices...47 Annexure D: Industrial Classification: Construction: 2002 Prices, R Millions...48 Annexure E: Rework of Data: Operational Phase...49 Annexure F: Industrial Classification: Operation: 2002 Prices, R Millions...50 Annexure G: Economy-Wide Impact: Construction: 2002 Prices, r Millions (Employment: Numbers)...51 Annexure H: Economy-Wide Impact: Operation: 2002 Prices, R Millions (Employment: Numbers)...52 Annexure I: Issues Trail...53 List of Tables Table 1: Value of direct and indirect investment costs during construction phase: Table 2: Employment during construction phase: Table 3: Estimated financial flows during operation: Table 4: Direct employment during operation phase... 9 Table 5: Pechiney: Financing plan...14 Table 6: Pechiney: Sources of debt...14 Table 7: Economy-wide impact: construction phase: : 2002 Prices, R millions (Employment: Numbers)...18 Table 8: Economy-wide impact: operational phase: 2002 prices, Rmillions (Employment: Numbers)...22 Table 9: Geographic disaggregation of the Type II impact of the operation of PAS Table 10: Summary of macroeconomic impact...24 Table 11: Impact assessment of macroeconomic impacts: without mitigation...27 Table 12: Impact assessment of macroeconomic impacts: with mitigation (or optimisation)...28 Table A1: Transaction table...35 Table A2: Condensed input-output table for South Africa: 2000 (Rmil, basic prices)...37 Table A3: Commodity flows by sector of origin and destination (symbolic terms)...37 Table A4: Inter-industry technical coefficients (symbolic terms)...38 Table A5: Inter-sectoral technical coefficients: South Africa: Table A6: Aggregated input-output table for South Africa: Basic R Million Prices: Table A7: Sectoral Coefficients and Multipliers for South Africa: Aluminium Pechiney Coega EIA iii

6 Glossary Aggregate production Total final and intermediate production Capital formation or investment Investment in fixed capital stock in a given time period Consumption of fixed capital or Depreciation Consumption of fixed capital due to use or technological change within a given time period Cross section data Matrix of data, indicating the relationship between various aggregates within a time period Direct domestic investment Final investment in locally produced goods within a given time period Direct impact Within the context of input-output modelling it refers to the first round initial change of a variable Domestic demand Final demand by citizens within a given time period Employment Employed by an establishment or considered selfemployed Final goods and services or final demand Goods and services used for final consumption by the end user of the product within a given time period General equilibrium National supply equal national demand for all goods and services Government revenue Government income within a given time period Gross domestic product (GDP) Value of all final goods and services produced within the borders of the country within a given time period Gross geographic product (GGP) Value of all final goods and services produced in a specific local geographic area of the country within a given time period Gross national disposable incomevalue of all final goods and services produced by citizens of the country within a given time period Gross operating surplus Mixed income; also the return to capital and entrepreneurship Indirect impact Within an input-output context it refers to the direct as well as knock-on (downstream) eco nomic impact (income treated exogenously) Induced impact Within an input-output context it refers to the direct as well as knock-on (downstream) and upstream economic impact (income treated endogenously) Input-output table System (matrix) listing all industrial sectors input and output relationship for a specific year Intermediate goods and services Goods and services that are used in the production process Net present value Discounted future current values in terms of current prices (deflating the series) Production account Account of all the production activities within a country within a given time period Aluminium Pechiney Coega EIA iv

7 Systems of National Accounts International system of accounting for national aggregates The current account of the balance of payments The financial account of the balance of payments External account of the country with the rest of the world with respect to the imports and exports of goods and services External account of the country with the rest of the world with respect to financial assets List of Abbreviations and Acronyms used BEPA Bureau for Economic Policy and Analysis (Research arm of the Department of Economics, University of Pretoria) BoP Balance of Payments C Private consumption CDC Coega Development Corporation G Government consumption GDP Gross domestic product GGP Gross geographic product GNDI Gross national disposable income I Capital formation of gross fixed investment IDZ Industrial development zone LME London Mercantile Exchange M Imports NPA Ngqura Port Authority PAS2005 Pechiney aluminium smelter 2005 RSC Regional service council STC Secondary tax on companies X Exports "This report is to be cited as follows: Blignaut J and Schoeman N J Specialist study: Macro-Economics. In: Environmental Impact Assessment for the proposed Aluminium Pechiney smelter within the Coega Industrial Zone, Port Elizabeth, South Africa. Specialist Studies Report. CSIR Report No. ENV-S-C B, Stellenbosch, South Africa. Aluminium Pechiney Coega EIA v

8 1. INTRODUCTION To meet the growth in international demand for primary aluminium the France -based aluminium producer, Aluminium Pechiney, earmarked three possible locations to establish another smelter in Argentina, Australia and South Africa respectively. Due to instability in Argentina, this site is, however, no longer considered. Financial, technical and environmental feasibility studies are currently underway at the Australian and South African sites before a final decision is taken. The proposed project (PAS 2005) will consist of: 336 electrolysis cells (or pots), producing approximately tonnes of solid aluminium annually; an anode baking plant; electrical substation; raw material silos; a cast house; loading facilities at the Port of Ngqura; and a conveyor belt between the proposed Port of Ngqura and the smelter. The total fixed investment will be approximately R8,2 billion (in 2002 prices - see Annexure D) although the total financial cost of the project is estimated at approximately R22 billion. It is further estimated that the project will employ approximately 750 people directly when in full operation. A further sub-contractors will be employed on a full-time basis at the smelter. It is envisaged that 95 per cent of the aluminium produced (R5,1 billion in 2002 prices) will be exported. This study investigates the macroeconomic impact of this proposal and forms part of the Environmental Impact Assessment of this proposed investment in the Coega Industrial Development Zone (IDZ). In analysing the macroeconomic impact of the envisaged Pechiney aluminium smelter (the PAS2005 project), this study firstly provides the economic context within which the proposed smelter will be constructed and operated. Thereafter the approach to the study and a background to input-output modelling is provided prior to outlining the economics of the PAS 2005 project and the input data used and clarifying assumptions made. In the penultimate section the research results are discussed in terms of the impacts on the national and local economy followed by a conclusion. 2. MACROECONOMIC AGGREGATES AND THE NATIONAL ECONOMY 2.1 Macroeconomic aggregates Economic growth is usually expressed in terms of the percentage change in the Gross Domestic Product (GDP). The GDP refers to the total production (value) of goods and Aluminium Pechiney Coega EIA 1

9 services produced within the borders of a country during a particular time period, usually one year. The important (conventional) determinants of the long run growth path of output in a country are: labour - the people available for work; capital - equipment, structures and other needed facilities for production; and technology - the knowledge about how to use labour and capital to produce goods and services. Technology is perhaps the most abstract of the three determinants of growth, and is more difficult to measure than labour and capital. Technology also includes anything that influences the productivity of workers or capital. It also includes the level of efficiency concerning the organisation and management of business. Employment (labour) Growth in the number of people available for work is an important source of the growth of GDP. Fluctuations in employment closely follow the fluctuations in real GDP. Firms lay off workers as the economy s production falls and also hire less new workers. As the economy begins to recover (GDP increases), employment tends to grow again. This close association between production and employment as the economy fluctuates is one of the key facts of macroeconomics. Recurrent recessions result in serious social problems because they involve large-scale job losses. Mirroring the fluctuations in employment are the fluctuations in the unemployment rate, which is the percentage of the labour force who are unemployed. A concern recently is the fact that due to the capital intensity of investments and the high degree of competitiveness and efficiency, one does tend to observe GDP growth without the concomitant growth in employment - a phenomenon called jobless growth. Investment (capital formation) An increase in capital stock is an additional factor influencing the GDP. Capital is the main determinant of the number of labourers who can be employed. Labour is put into motion by capital. Capital accumulation promotes the efficiency of the economically active population since it provides workers with better equipment, and, most importantly, makes a more extensive division of labour possible. Capital accumulation serves to increase both total output and output per worker. An economy s rate of progress is proportional to its rate of investment. Keynes, a world-famous economist, argues that investment is the primary driving force in the economy and that it fluctuates because of shifts in business expectations. These expectations are based on calculated estimates of future changes in demand and prices that businesses are likely to face. This means that the demand for capital declines when the price of capital rises. The price of capital rises the price of new equipment rises or the interest rate rises. Note also that investment is a function of the general income level (GDP) in the economy. This would suggest that investment will increase during economic upswings and decrease during downturns. Aluminium Pechiney Coega EIA 2

10 Exports The Balance of Payments (BoP) is an accounting record of a country s involvement in international trade (exports and imports) and international capital flows. The former category of transactions is indicated on the current account of the BoP and the latter on the capital account. An increase in exports, for example, would therefore lead to a surplus on the current account of the BoP. Exports depend not only on foreign income levels, but also on the price ratio (terms of trade) and the exchange rate. Suppose foreign income levels increase, they might increase the demand for local products (i.e. stimulate exports), which would lead to an improvement in the current account of the BoP (a surplus develops or the deficit shrinks). What would the consequences of this surplus be for the current account and thus improved BoP, on the economy of a country? The BoP has a direct impact on three key economic variables: the foreign reserves; the money supply (monetary liquidity); and the exchange rate. Increased exports (surplus on current account) cause the amount of foreign reserves in the country to increase. Foreign reserves are critically important since they are essential in paying for imports. A country cannot sustain a BoP deficit for an indefinite period of time. Eventually there will be insufficient foreign reserves to pay for imports - especially essential imports such as oil. Another consideration is that, as soon as foreign reserves reach relatively low levels, one can expect interest rates to increase, in order to restrain expenditure and therefore imports. Obviously such a step affects the economy negatively. A BoP surplus influences the money supply positively in the sense that it is a monetary injection into the economy, which will be followed by the normal multiplier process. The foreign trade multiplier is the amount by which the equilibrium national income of an open economy will be raised by a unit increase in investment or exports. The same effects (as discussed above) concerning the multiplier process will follow. A BoP surplus (due to increased exports) implies an excessive demand for rands, and hence upward pressure on the value of the rand. This is so because a foreign importer must exchange his/her means of payment, e.g. dollars, for South African rand. If exports increase, the demand the rand increases and the rand (exchange rate) will improve. Should prolonged pressure be exerted on the BoP, the reverse is obviously true. Pressure on the BoP can be either in the form of imports or capital outflows that exceeds exports. It is noteworthy that, according to international experience, economic growth performance has been more satisfactory under export-promotion strategies, than under importsubstitution strategies. The relationship between export performance and growth is significantly strong. There is little doubt in the international arena about a positive link between export performance and economic growth rates. Aluminium Pechiney Coega EIA 3

11 2.2 The GEAR strategy It is in this context that the macroeconomic policy in South Africa is currently based on the Growth, Employment and Redistribution (GEAR) strategy. The conditions for development according to the strategy entail the following (RSA 1996): 1 Outward-orientation: The expansion of the export sector by making it internationally competitive through a depreciated exchange rate, gradual relaxation of exchange controls and a liberated trade policy (e.g. lowering of import tariffs). 2 Stability and profitability: The creation of a stable environment which will boost confidence and encourage a profitable surge in private investment through tax incentives to stimulate new investment in competitive and labour-absorbing projects and the promotion of small and medium-sized businesses. 3 Public sector efficiency and improved social and physical infrastructure: The increase in efficiency in public sector capital expenditure and service delivery; public asset restructuring (privatisation); better education, health and welfare services, housing and reform and infrastructure creation; fiscal discipline; monetary discipline; good policy co-ordination. 4 Decentralisation in industrial and infrastructure development: High emphasis is placed on sectoral and regional industrial and infrastructure development. 5 Labour market flexibility and human resource development. 6 Social compact: The establishment of a social agreement between business, labour and government to facilitate wage and price moderation, underpin accelerated investment and enhance public service delivery. From the above synopsis of GEAR, three points need to be highlighted: 1 the importance of economic liberalisation (e.g. trade and labour market liberalisation); 2 the strong institutional character of the policy (e.g. the establishment of proper communication structures, sound governance and infrastructure creation); and 3 the absence of any reference to the natural environment and/or externalities. Within a local context spatial development initiatives and industrial development zones have been developed to implement this macroeconomic strategy. 2.3 Macroeconomic indicators The GDP was estimated to be R million in 2001 of which R million or 15 per cent was capital formation or gross fixed investment, approximately 4 per cent or R million net exports (exports less imports) and 62 per cent (or R million) final consumption by households. In real terms the GDP grew by 2,2 per cent in The GNDI was estimated at R million, or R million (4%) lower than the GDP reflecting transfer payments to the rest of the world in the form of remittances. The GNDI grew by 1,2 per cent in real terms in Aluminium Pechiney Coega EIA 4

12 Unemployment was estimated to be approximately 23 per cent or 4 million of the economically active population using the restricted definition, or 34 per cent (5,5 million) in 2000 using the expanded definition. The restricted definition excludes the disillusioned jobseekers from the equation whereas the expanded definition includes them. The balance on the current account of the balance of payments was estimated at a deficit of R1 687 million whereas the financial account had a deficit of R million in The total deficit was therefore R million. There were, however, unrecorded transactions to the value of R million, which implied a net inflow of R5 182 million. Relative to the GDP and GNDI and also private consumption, the balance of payments totals are small and any major changes influencing the balance of payments will have an impact on foreign reserves, the exchange rate and domestic interest rates. 3. APPROACH TO THE STUDY The specialist addresses macro-economic issues of concern, which includes: a brief overview of the respective roles of investments and exports in the South African economy; the quantification of the macro-economic impact of the expansion. This will be done in terms of generic macro -economic variables, including employment, and its contributions to GDP and the balance of payments; and the evaluation will consider both the proposed development and upstream and downstream opportunities associated with the proposed expansion. In the macroeconomic benefits study, the impacts of the proposed development on gross domestic product (profits, remuneration, tax revenues), the balance -of-payments (foreign exchange reserves) and employment are estimated. Information from existing sources is fed into an economic input-output model that will assess the impacts of the proposed development on the national economy. These economy-wide effects will then be interpreted within a provincial context. A value-added approach (VAD) is used. Following the standard national accounts convention, value added to the national economy comprises wages, profits and taxes and an adjustment for capital depreciation. This method had been used successfully by the CSIR in previous EIA studies and the University of Pretoria in a number of regional and national projects of similar kind. This macroeconomic analysis was done according to the standard macroeconomic variables such as: gross domestic product (GDP); gross national disposable income (GNDI); gross geographic product (GGP); capital formation or investment; income generation; employment; the current account of the balance of payments; and government revenue. Aluminium Pechiney Coega EIA 5

13 In combination, these variables provide a good indication as to the magnitude and impact of any investment project of this kind. The modelling of the domestic demand, and the impact of the investment measured in terms of the variables listed above, was done using standard input-output techniques based on a 19-sector input-output table for South Africa for Excluded, however, is an elaborate actuarial analysis of the financial flows as well as an evaluation of the possible negative externalities as a result of the project. 4. BRIEF INTRODUCTION TO INPUT-OUTPUT TABLES AND THEIR USE An input-output table provides a breakdown of inter- and intra-industry flows by disaggregating the inputs and the respective outputs. Input to a typical production process, i.e. aluminium production, includes labour, capital and raw material which can either be imported, i.e. Alumina, or produced locally, such as electricity. Outputs would refer to the final product that could be consumed either locally or exported and are generally measured in terms of their contribution to GDP or GNDI. One of the main advantages of input-output tables and the ensuing modelling that one can base on input-output tables is that they show how much a given change in demand in one sector will influence demand in other industries which are linked to the first sector, either as a provider of inputs, or as a receiver of outputs. In such a way the economy-wide as well as region-wide impact of a prospective change in demand can be measured in terms of various variables, such as those mentioned above in section 3. The detail mechanics of how an input-output table is constructed and the ensuing modelling done are indicated in Annexure A below. But as a general proposition one needs the following basic information before modelling could begin: a recent input-output table; input-output multipliers; and project information, i.e. total production, structure of input requirement; employment requirement. As mentioned in Annexure A also, official input-output tables are not produced regularly and this leads to serious data constraints. To solve this information gap a small number of consultants produce input-output tables and/or social accounting matrixes themselves in an effort to improve the data situation. This study made use of a social accounting matrix for 2000 that had been developed by Conningarth Consulting (2002) based on the 1998 supply and use table and then reworked it to an input-output table. A highly aggregated version of this input-output table with the disaggregated coefficients and multipliers is contained in Tables A6 and A7. The main shortcomings of input-output tables are embedded within its underlying assumptions, of which the main ones are: Weaknesses that might occur as a result of data inadequacies; Aluminium Pechiney Coega EIA 6

14 Input-output tables are based on fixed production coefficients and structures and also constant returns to scale. Any economy is dynamic and its structure does tend to change over the medium term. After a period of, say, five years, the input structures have changed significantly and the table then becomes unreliable; Input-output tables are excellent tools in analysing the various potential impacts of planned projects or policies, and are therefore very useful in providing data upon which informed decisions can be taken regarding project priority and impact, especially over the short term. When used for forecasting purposes over a longer period, the exercise becomes hypothetical and only useful for benchmark purposes; Although a powerful tool as described above, one should be cautious not to expect a direct match between predicted outcome and realised outcome over the longer term once a project is implemented. The reasons for that are plentiful, but the main ones are: o Modelling using input-output tables assumes constant inter-industry relationships; o Modelling using these tables, like all other modelling, occurs under the ceteris paribus assumption - i.e. all other things outside the modelling parameter remain constant - so no external shocks and no other interventions; o During any economic activity, leakages do occur, implying that, for example, the impact of a R1 million investment could be diluted. Examples of leakages are the effects of taxation, savings, imports and various forms of wastages or inefficiencies. Should one require the extent of these leakages, information pertaining to the tax and savings structures is required on a highly disaggregated basis. It is not possible to model the effect of wastages and inefficiencies beforehand since they are unknown; o The table assumes that all the provinces within the country have the same economic structure. This could lead to wrong answers should the provincial or local economic structure differ substantially from the national economic structure; and o The informal sector is excluded from the table. No linkages between the formal and the informal sector are therefore modelled. Aluminium Pechiney Coega EIA 7

15 5. THE PAS2005 PROJECT: INPUT DATA AND DESCRIPTION 5.1 The input data The data as provided by Pechiney for this project will be discussed here. Pechiney provided the following data on 14 August 2002 as being their latest and best estimates of the direct investment costs of the PAS2005 project. The total investment cost of the project including both direct ($1 042 million) and intermediate (indirect) cost is estimated at approximately $1 654 million. Table 1: Value of direct and indirect investment costs during construction phase: R million Total Total Grand total $ Million Roofing & cladding Piping & vessels Steel Civil works Aluminium conductors Mechanical equipment Miscellaneous Transport Salaries Sub-total: direct investment Temporary facilities 30 Construction services, project management, direction and promotion 250 Licence and technical assistance during construction 151 Start-up costs and insurance 84 Contingencies 90 Escalation of the above 65 Less grants -55 Sub-total : indirect investment 615 Total: Direct and indirect cost (approximate) Working capital 137 Reserve account 91 Debt financing cost 211 Total investment (approximate) Source: Pechiney (2002). Aluminium Pechiney Coega EIA 8

16 Table 2: Employment during construction phase: Peak construction workforce Local employees Temporary expatriates Unskilled Semi-skilled Skilled Highly skilled Total Source: Pechiney (2002). Note :...This includes technical expatriates for pre-commissioning and commissioning phases. Table 3: Estimated financial flows during operation: 2006 Annual input/output US$ Millions Imported component % Aluminium sales (output) 775 Alumina, Coke, Pitch Logistics costs Other raw materials 8 Electricity 94 Personnel 23 Operating costs 65 Administration costs 8 Local taxes 1 Corporate taxes 1 STC 20 Depreciation (books) 94 Financial cost 89 8 Net income 107 Source: Pechiney (2002). Note: Due to a high depreciation rate, no corporate tax will be payable in the year 2006, but it is estimated to be approximately US$87 million as of Table 4: Direct employment during operation phase Employees Range Annual base wage (R) Management an d staff Operators Sub contractors Total Source: Pechiney (2002). Further information: Corporate tax: The project is subject to normal corporate income tax at 30 per cent, STC at 12,5 per cent. Indirect tax: Property rate: assumed to be R10 million per year; Environmental rate: approximately R0,4 million per year; Aluminium Pechiney Coega EIA 9

17 RSC establishment levy at 0,152 per cent of turnover; and RSC services levy at 0,38 per cent of payroll. All these taxes are included in Table 3. Institutional agreements: Regarding the power supply agreement with Eskom, three price options are included, one of them linked to the London Mercantile Exchange (LME) - this implies linking the price of electricity to the international price of Aluminium. However, no decision has been made yet as to which option or combination of options will be chosen for the final contract; Eskom will provide the power lines; NPA will provide the port; and The CDC will provide other infrastructure such as roads and clinics. Project financing: A South African discount rate of 11 per cent is used in project value (calculation on 35% of this debt from RSA); The expected lifespan of the operation is 40 years; and The investment will be financed by 40 per cent equity and 60 per cent debt and the detailed breakdown is provided below. Tax breaks/incentives: Not included, however, is the fact that the project has confirmation from the authorities that it would be eligible for incentives from the Strategic Industrial Projects and Skills Support Programme under which firms could claim back money based on skills programmes completed. Distribution of net income: Corporate tax from 2013 onwards of 30 per cent; Shareholders dividends: 65 per cent international shareholders and 35 per cent local shareholders; and Retained income: 65 per cent repatriated and 35 per cent reinvested in South Africa. 5.2 Assumptions The research conducted is based on the following assumptions (which have been checked by both the EIA project manager and Pechiney and confirmed on 14 June 2002): R:US$ exchange rate for 2002: R10,50:US$. R:Euro exchange rate for 2002: R9,50:Euro. 11 per cent as the discount rate (used to discount future values back to 2002 present values). The macroeconomic study will only allude to financial flows but will not investigate the full impact on the financial markets of, amongst others, the debt, savings, interest payments, etc. Aluminium Pechiney Coega EIA 10

18 Total investment capital to be financed is assumed at US$2 090 million: o Equity $797 million (local part 35%); o Debt $1 184 million (local part 39%); and o Commissioning cash flow $112 million. In order to divide the total value of the construction into the various years, the following breakdown has been used: 2003 = 35%; 2004 = 50% and 2005 = 15%. Sectoral classification: Construction: Pechiney item: Industrial sector: Roofing & cladding Iron and steel Piping & vessels Iron and steel Steel Iron and steel Civil works Construction Aluminium conductors Other manufacturing Mechanical equipment Machinery Miscellaneous Other manufacturing Transport Transport Personnel (Remuneration or compensation of employees) Operation: Pechiney item: Industrial sector: Alumina, Coke, Pitch Mining Logistics costs Transport Other raw material Mining Electricity Electricity Operating cost Iron and metals 20% Machinery 20% Other manufacturing 30% Glass and bricks 30% Administration cost Financial and business services Local taxes (Taxes) Corporate taxes (Taxes) STC (Taxes) Depreciation (Depreciation) Finance cost (Interest payments) Personnel (Remuneration or compensation of employees) Note: The items shown in parenthesis are not industrial sectors but financial flows or valueadded components and incorporated as such in the analysis. Aluminium Pechiney Coega EIA 11

19 5.3 Research method Construction phase The following procedure was followed to rearrange the data provided to be able to quantify the macroeconomic impact of the construction phase: First the input data provided was divided over the years of construction as shown in Annexure B. Thereafter the absolute values were discounted to their 2002 net present value to account for inflationary effects. See Annexure C. The values shown in this annexure therefore the net present value of the total inve stment in rand. Lastly, the 2002 net present value of the input data was reclassified according to its industrial classifications. See Annexure D Operation phase The following procedure was followed to rearrange the data provided to be able to quantify the macroeconomic impact of the operation phase: First, as shown in Annexure E, the input data was split between its domestic and external components. Thereafter the data was expressed in terms of 2002 US$ values and, lastly, rewritten in to 2002 rand values. In the final step the data was reclassified according to industrial sectors. See Annexure F Structure of model After the data base had been compiled for both the construction and operation phases (see Annexures D and F), the domestic demand was modelled using the input-output table coefficients as shown in Table A7. The change in domestic demand was modelled to determine the impact that this change in domestic demand will have on GDP. Included in this measure were all the GDP components, namely, income, gross operating surplus and net indirect taxes. All these other variables are shown separately in the analysis for the sake of completion and explanation. With regard to the operation phase it should be noted that the model is based on the assumption that 95 per cent of the sales will be exported. An important facet of this study is the treatment of imports since it reduces GDP. As a point of reference the national account identity of: Y = C + I +G + (X-M) will apply, where Y = GDP, C = private consumption; I = capital formation or investment; G = government consumption; X = exports and M = imports and X-M = the change on the current account of the balance of payments. Aluminium Pechiney Coega EIA 12

20 During the construction phase, the imported goods, once across the border, becomes capital formation or investment. From a GDP perspective the negative import entry is then offset by an equivalent positive investment entry. The imports therefore have a zero impact on GDP. The import component, however, has a negative impact on the current account of the balance of payments. The impact of these imports on the balance of payments as a whole depends on the finance strategy. If the imports are financed from abroad, then that finance is seen as a capital inflow. This implies a positive entry on the financial account of the balance of payments. The negative entry on the current account is then offset by this positive entry and the total impact on the balance of payments is zero. This debt should, however, be repaid during the operation phase. This would imply a capital outflow and a negative entry on the financial account of the balance of payments that will lessen the impact of the exports to that extent, reducing the domestic value of the project. Should the capital be sourced domestically, no capital inflow entry will be recorded and hence no negative entry on the current account, with the result that the impact on the balance of payments as a whole equals the impact on the current account. The money would then be borrowed in the money and/or capital market, which will increase the demand as well as the stock of money with pressure on inflation and interest rates. The money borrowed locally will reduce the opportunity for other potential (possibly local) borrowers of money. Repayment of the debt will also have no impact on the financial account of the balance of payments and therefore the positive change in the current account will be equivalent to the total export component. The import of raw material during the operation phase, however, is treated differently from that used during the construction phase discussed above. These imports are intermediate goods that do not become investment. The import component during construction should therefore be subtracted from the GDP as shown in the identity above. Furthermore, since imports represent current expenditure, they will have no effect on the financial account of the balance of payments. The impact on the balance of payments as a whole is therefore equal to the change in the current account, i.e. the difference between the exports and imports and whatever component of capital outflow as a result of the servicing of the debt. As mentioned under the assumptions section (section 5.2) the required infrastructure needed to service the project will be done by the Coega Development Corporation (CDC) and the Ngqura Ports Authority (NPA). The macroeconomic impact of this investment has not been quantified in this analysis because of its collective nature as a typical public good. In this analysis investment of the kind could therefore not be divided and ascribed to individual or company efforts. The impact of infrastructure development has been quantified elsewhere in the form of a cost-benefit analysis. Part of this study, however, includes the calculation of the tax and rent payable by Pechiney to the local authority as service provider. The capital expenditure in infrastructure is therefore excluded, but the current income generated included. The results of this exercise will be discussed subsequently. Aluminium Pechiney Coega EIA 13

21 6. IMPACT OF THE PAS2005 PROJECT ON THE SOUTH AFRICAN ECONOMY: THE RESULTS 6.1 Financial impact Table 5 captures the financing plan of Pechiney (see also Table 1). From this table it is clear that by far the majority of funds will be sourced through borrowing (57%), followed by equity (38%) and the commissioning cash flow as a result of the operating profit during the first 8 months of operation. The Equity/Debt ratio is therefore 40:60. 35% of the equity (US$279 million) will be held by South Africans (and Imbali is responsible for facilitating the participation of a Black Empowerment Enterprise in this regard) and US$518 million will be held by foreigners. Table 5: Pechiney: Financing plan Sources US$ million % Uses US$ million % Equity % Capital cost % Debt % Initial working capital 137 7% Commissioning cash flow 112 5% Initial DSRA 1 funding 91 4% Financing cost % Total sources % Total uses % Source: Pechiney (2002). Notes: 1 Debt Service Reserve Account In terms of the financing plan, 79 per cent will be used for capital cost, 10 per cent for financing cost, 7 per cent for initial working capital and 4 per cent allocated to the Debt Service Reserve Account. Table 6 provides a breakdown of the sources of debt. It is expected that 39 per cent of the total debt drawn (or US$465 million (US$238 million + US$227 million)) will be from local sources whereas US$719 million will be financed from abroad. Table 6: Pechiney: Sources of debt Source of Debt Committed (US$ million) Drawn (US$ million) Debt repayment ECAs and Bilaterals Start Jan years International Banks Start Jan years South African Financiers Not stated Total Source: Pechiney (2002). Note: Local banks in South Africa expected to lend in ZAR. Aluminium Pechiney Coega EIA 14

22 The total impact on the local financial markets (equity plus debt) is expected to be US$744 million (US$279 million + US$465 million - i.e. R7 812 million), or 2 per cent of the national acquisition of assets in 2000, whereas the external component will be US$1 237 million (R million) or approximately 62,5 per cent of the total funds allocated to the project in terms of debt and equity, namely US$1 982 million. Remittances based on this external component will flow out of the country either in the form of debt repayment, investments or dividends. As stated in the debt repayment column, it is anticipated that the international debt will be redeemed over a 14-year period, which translates, on average, to US$89 million per annum. Combined with these capital repayments abroad, 61 per cent of the financial cost listed in Table 3, or US$54 million, will also be paid to international debtors, totalling US$143 million per year for 14 years. It is unclear how and when the local financiers will be paid and at what rates, but it is assumed that it will happen concurrently with that of the foreign debtors. In addition to the redemption of the international debt, it is likely that a considerable portion of the company profits and dividends (return on equity) will be invested abroad as well, implying capital outflows. It is currently not possible to determine the size of these outflows since the company structure and the allocation of shares have not been confirmed yet, but based on the premises that 65 per cent of the equity is expected to be held by foreigners, the potential additional outflow is $70 million. The treatment of the depreciation funds is also unce rtain at this stage (US$94 million - see Table 3). A significant portion of these funds could also be invested elsewhere. Based on the fact that 62,5 per cent of total debt and equity is from abroad, this translates into a possible outflow of US$59 million should the same ratio be applied. In total the potential outflow of money in the form of remittances and international investments are US$272 million or R2 856 million. Outflows through the financial account of the balance of payments are $202 million ($59 million + $143 million) or R2 121 million whereas the outflow through the current account of the balance of payments, which also impacts on the GDP, is $70 million or R735 million. The impact of these outflows will be discussed later on when the impact of the real flows is also taken into consideration. To fully appreciate the impact of these financial flows on the economy, a detailed actuarial study and financial analysis is required with full knowledge as to the proposed debt repayment structures, equity holdings and company structures. 6.2 Economy-wide impact: Construction phase The results of the economy-wide modelling of the impact of the construction phase are shown in Annexure G and are illustrative of the expected total change, in 2002 prices, of each of the respective variables over the 26 month construction period. It should be remembered that only the investment that is sourced domestically has a knock-on effect in South Africa. That is why only the domestically sourced inputs are modelled. Furthermore, the investment sourced from South African sources will have a direct and indirect effect Aluminium Pechiney Coega EIA 15

23 through the economy (the so-called Type I effect) and also a direct, indirect and induced effect (the so-called Type II effect due to an increase in consumer expenditure). Based on the data provided (Table 1 and Annexures B, C, and D), total direct investment, domestic as well as the imported component, is estimated to be R8 120 million in 2002 prices (see Annexure D). This investment is to be spent over 26 months stretching from 2003 to Fifty seven per cent of the total investment, or R4 647 million, is spent on imported goods and R3 473 million comprises domestic demand (see Annexure D). This investment will be financed through a combination of equity funds (40%) and debt (60%), see also section 6.1 in this regard of which the 62,5 per cent is foreign funds. The impact of this investment will subsequently be discussed. Impact on the balance of payments The balance of payments is South Africa's external account, indicating the total value of transaction (imports and exports) with countries abroad. The international flow of goods and services are accounted for in the current account of the balance of payments whereas financial flows are accounted for in the financial account of the balance of payments. As a result of this investment, the current account of the balance of payments will enjoy a surplus since the total of the direct import component (R4 647 million) and the import component of the downstream domestic requirement of R2 259 million is offset by an inflow of R million. The net inflow therefore implies R6 084 million. The total import requirement during construction therefore amounts to approximately R6 906 million or 2,5 pe r cent of total national imports. The surplus capital inflow will support the currency, but as will be indicated in the next section, lead to substantial outflows during the operation phase in the form of debt repayments and remittances abroad until Finance that is sourced from abroad will act as a temporary inflow during the construction phase, but will lead to a longlived outflow as stated above. Finance sourced domestically will have an inflationary impact and will squeeze the financial market as to crowd other potential investors out because of scarcity. An optimum financial package should be sought and it is recommended that a proper actuarial and financial analysis be done on this issue. Impact on income and employment Due to the technical requirements of the project, the construction of the smelter is highly capital-intensive and based on a large volume of imported goods and services. From Annexure C it is clear that only R821 million of the total of R4 304 million additional domestic demand (or 19%) will be used for employment. It is estimated that during the peak construction period Pechiney will employ approximately direct employees and Table 4 provides a breakdown in terms of level of skills. The PAS2005 project will result in an additional income stream of between R1 928 million (Type I) and R2 802 million (Type II) over the construction period (see Annexure G). The total effect is equal to 0,4 per cent of total remuneration in South Aluminium Pechiney Coega EIA 16