AfDB. Africa Economic Brief. Fairer Mining Concessions in Africa: How Can this be Achieved? OUTLINE. Key Issues. Chief Economist Complex

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1 Volume 3 Issue 3 April 2012 AfDB Chief Economist Complex Africa Economic Brief OUTLINE 1 Introduction 1 2 A Review of Mining Deals in Africa 2 3 Operationalizing Fair Mining Concessions 3 4 Conclusion 6 The findings of this Brief reflect the opinions of the authors and not those of the African Development Bank, its Board of Directors or the countries they represent. Fairer Mining Concessions in Africa: How Can this be Achieved? Ousman Gajigo, Emelly Mutambatsere and Guirane Ndiaye 1 Key Issues Mining is an important sector in Africa. The sector s potential contributions to development are high but not always realized due to limited government revenues from concessions. A fairer sharing of resource rents that increases government shares and allows investors to realize reasonable returns is necessary for the sector to better contribute to development. Mthuli Ncube Chief Economist and Vice President (ECON) m.ncube@afdb.org Charles Leyeka Lufumpa Director Statistics Department (ESTA) c.lufumpa@afdb.org Steve Kayizzi-Mugerwa Director Development Research Department (EDRE) s.kayizzi-mugerwa@afdb.org Victor Murinde Director African Development Institute (EADI) v.murinde@afdb.org Statistics Department (ESTA) and Development Research Department (EDRE). The brief reflects the opinions of the authors and not those of the African Development Bank, its Board of Directors or the countries they represent. We are grateful to our colleagues in the Development Research Department (EDRE) for helpful comments and suggestions.

2 Table 1 Examples of recent mining concession renegotiations in Africa Country Project or company Mineral Year Congo, D.R. Axmin Gold 2009 Guinea Simandou Iron Ore 2011 Ghana Anglo Gold Ashanti Gold intention to renegotiate Liberia Arcellor-Mittal Iron Ore 2006 Malawi Kayerekela Uranium 2011 Mozambique BHP Billiton, Aluminum, Coal and Titanium intention to renegotiate Sierra Leone Tonkolili Iron Ore 2011 Tanzania Barrick Gold Gold 2007 Source: Gajigo et al. (2011a). 2 One important aspect of fairness that we do not cover is intergenerational fairness. Another aspect is the fairness across regions of a given country in how the gains from the extractive sectors are shared. These are important dimensions, and the extent to which they are taken into account in countries depends on their governance levels. 2

3 Vo l u m e 3 I s s u e 3 F e b r u a r y Additionally, most of the earnings are repatriated and the infrastructure build is mostly captive. South Africa has strict labor standards that enforced. Furthermore, the country also has a strong labor union within the mining industry. A PricewaterhouseCoopers study in 2011 shows that labor cost is the largest component of cost in mining in the country ( ZA/za/assets/pdf/pwc-sa-mining-2011.pdf). 3 A f r i c a n D e v e l o p m e n t B a n k

4 Vo l u m e 3 I s s u e 3 F e b r u a r y The World Bank strategy document (World Bank 1992) that fed into mining reforms in Africa benefitted from feedback from mine investors through an enterprise survey of mining companies and investors. Additionality is the term used by several DFIs to denote the value they bring to projects that commercial lenders cannot. It can also entail the reduction of political risk, crowding-in of commercial lenders or the implementation of rigorous environmental and social standards. Unlike other sectors (for example, manufacturing or services), a mining firm owes a large part of its returns to the exploitation of a resource it does not own (i.e. the mineral and the land). 4 A f r i c a n D e v e l o p m e n t B a n k

5 8 What commodity market price is used depends on the details on the negotiated concession. For traded commodities, the referent price could be the closing price of a particular established, well-reputed commodity exchange. An example is the London Metal Exchange. 9 By model mine we mean a financial model of fictional mine. However, the parameters under such models are based on values comparable to actual mines. 10 The estimated ETRs were based on several assumptions, which are quite realistic when compared to situations in typical resource-rich African countries. For example, the royalty rate assumption was 3%, and realistic range for ore grade, mine capacity, etc. were used. Furthermore, the ETR was based on conservative assumptions on commodity prices (e.g. they used USD 400/once for gold when the average between 2005 and 2011 is at least twice that amount). This is significant because the magnitude of the positive effect of commodity prices on the internal rate of return (a measure of profitability of the mine) is far higher than on the ETR. 5

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8 8 a p p e n d i c e s

9 a p p e n d i x A 9

10 a p p e n d i x B Table 2 Key sources of government revenues in major mineral-rich African countries. These rates apply to large scale mining operations, not artisanal mining Countries Enactment Year of the Latest Mining/ Mineral Code/Legislation Royalty Rate (%) for Precious Metals Free Carried Interest (minimum) for the Government (%) Corporate Income (Profit) Tax Botswana % 15% 25% Burkina Faso* % 12.5% 30% Cameroon 2001 (amended 2010) 2.5% 10% 35% Central African Republic % 15% 30% Congo, Democratic Republic of % 10% 30% Congo, Republic of % 10% 38% Gabon % to 6% n/a 35% Ghana** 2006 (amended 2010) 5%** 10% 33% Guinea % 15% 35% Ivory Coast % 10% 35% Liberia % n/a 35% Mali % 10% 35% Mauritania % 10% 25% Morocco % n/a 30% Namibia % 10% 35% Niger % 10% 35% Nigeria 2007 Not specified Not specified 35% Senegal % 10% 35% Sierra Leone % Negotiable 30% South Africa 2004 (royalty added 2008) 0.5%-7% n/a 37% Tanzania 1998 (amended 1999) 3% 10% 30% Uganda % n/a 30% Zambia % 10% 30% Note: This data was obtained directly from the countries mining codes/mineral laws. All Royalties are for precious metals and are ad-valorem (except for South Africa). *3% is the minimum rate. Actual royalty rates are indexed to commodity (gold) prices, they climb to 4% for gold prices between USD1000/oz and USD1300/oz, and 5% for prices above USD1300/oz. **The original 2006 act specified a royalty range of 3% to 6%, however an amendment has changed the rate to fixed level at 5%. Leaves it to the discretion of the Minister of Mines. Not specified in the mining code but in the corporate tax code. Source: Gajigo et al. 2012a. 10

11 a p p e n d i x C Figure 1 The equity internal rate of return (IRR) and effective tax rate (ETR) from a model mine (table 3) with no violation of the mining code and no tax holiday. The dashed line is the assumed corporate income tax rate 11

12 Figure 2 The equity NPV and the NPV of government revenues from a model mine (table 3) with no violation of the mining code and no tax holiday 12

13 MODEL MINE (with a 5-year tax holiday) Figure 3 The IRR and ETR from a model mine (table 3) with a 5-year tax holiday. The dashed line is the assumed corporate income tax rate 13

14 Figure 4 The equity NPV and government NPV from a model mine (table 3) with a 5-year tax holiday 14

15 Table 3 Simplified Cash Flow from a Model Mine. The assumed royalty rate is 3%, corporate income tax rate is 30% and free government equity of 10%. The baseline gold price assumption is USD1000 per ounce (oz) 000 USD Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Total Gold output (oz) 100, , , , , , , , , ,000 1,800,000 Total Revenues 100, , , , , , , , , ,000 1,800,000 Ad-valorem royalty (3%) 3,000 4,500 6,000 7,500 9,000 7,500 6,000 4,500 3,000 3,000 54,000 Mining Cost 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10, ,000 Processing & other costs* 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12, ,000 Reclamation cost ,000 Total Operation Cost 13,900 15,400 16,900 18,400 19,900 18,400 16,900 15,400 13,900 13, ,000 Net cash flow from operations 86, , , , , , , ,600 86,100 86,100 1,637,000 Debt repayment 40,000 40,000 40,000 40, ,000 Development & Depreciation 50,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000 35,000 35, ,000 Capital CostŦ 300, ,000 Working capital 10, ,000 Land payments ,600 Taxable Income (304,100) 59, , , , , ,700 99,300 50,900 50, ,400 Corporate income tax - 17,790 32,310 46,830 73,350 58,830 44,310 29,790 15,270 15, ,750 Government equity share (10%) - 4,151 7,539 10,927 17,115 13,727 10,339 6,951 3,563 3,563 77,875 Total Government Revenues 3,200 26,741 46,249 65, ,065 80,557 61,049 41,541 22,033 22, ,225 Net Cash Flow (304,100) 37,359 67,851 98, , ,543 93,051 62,559 32,067 32, ,775 Notes: We abstract away common component here, which is hedging gains or losses. *includes other operating costs such as assaying, general and administrative (G&A), leasing, refining, etc. Includes all repayments such as senior and subordinate principals and interest or cost overrun facilities. We abstract away from other taxes such as value-added tax (VAT), export tax, import tax or custom duties. ŦCapital costs that may been incurred before operations starts assumed to be included here. 15

16 AfDB Design, ERCU/YAL