The Zambian Mining Industry
Zambia plays an important role in
the global copper mining industry. The country contains the largest known
reserves of copper in Africa, holding 6 percent of known copper reserves in the
world. The history of Zambia’s copper mining industry is one of decline
followed by revival. From around 700,000 tonnes in the 1970s, copper production
fell to just 255,000 tonnes in 1998 as nationalization of the mines proved
counter-productive. However, since the mines were privatized in the 2000s,
investment and output have revived, and Zambia is regaining its world market
share. In addition, the industry is expanding geographically from its
traditional base in the Copperbelt to other parts of the country, where geological
surveys suggest significant deposits of copper.Copper plays a critical role in Zambia’s economy. Historically, the performance of the Zambian economy has followed the fortunes of copper mining closely. Although the economy is diversifying, copper mining continues to account for a sizeable part of GDP and is one of the lead industries for economic growth. However, Zambia—as a country—could benefit more from the mining industry. All countries that depend on natural resources face the shared challenge of taxation: determining tax levels and administering tax revenues in an effective manner that balances the needs of Government and investors. Mining depletes a valuable natural asset and taxing the mining companies is a way of generating savings that can be redeployed to increase the productive capacity of the rest of the economy, and thereby help sustain the country over the long-term. Despite the revival of the industry post-privatization, the mining industry’s contribution to government revenues in Zambia has remained low. The industry accounts for 15-18 percent of GDP and exports over US$3 billion worth of copper per year, but contributes just 8 percent of total tax revenue.
The reason for the low tax-take
lies in the Development Agreements that were signed by Government and the mines
at the time of privatization and that gave away generous tax concessions. By
early 2007, concerns about ‘resource robbery’ caused by the low tax-take were
creating a public outcry, which led the Government to impose, in 2008, a new
tax regime consisting of higher royalties and taxes, including a windfall tax.
Many aspects of the new regime, including the windfall tax, were ultimately
reversed in response to the fall in copper prices during the global financial
crisis. In 2009, the Government instituted another new tax regime with an
effective tax rate (47 percent) within the international range (40-50 percent).
This regime was designed to increase the level of government revenues, as mines
that were rehabilitated after privatization began to generate strong, positive
cash flows. The new tax regime, however, was challenged by the mining industry,
which argued that the invariability clauses in the original Development Agreements
precluded such changes. It is worth noting that a country’s legal/regulatory
environment is a key determinant for investors when they compare the attributes
of different destination countries. Exploration and mining companies seek a
stable, predictable and transparent regulatory environment in which the rules
of the game are clearly set out and administered on an equitable basis. These
characteristics are particularly important in the case of the mining industry,
given the high upfront capital investment and long payback periods involved. In
late-2010 the Government reached an agreement with a number of mines, and these
mines have already started paying in accordance with the new regime. Negotiations
continue with a few remaining mines in order to bring them into the fold of the
new regime. Due to its significant footprint and the debate over its tax
contributions to the country, the mining industry has remained the focus of
economic and political attention in Zambia.
Industry Structure
Many of the firms involved in
Zambia’s copper mining are the subsidiaries of small- to medium-sized firms (by
international standards of mining companies). However, there are notable
exceptions (such as Vedanta, Glencore, and the China Non-Ferrous Metal Mining
Group) that are major global players. Reports suggest that these are also
likely to be joined by BHP Billiton, the world’s largest mining house. Though
Zambian copper mining essentially is a private industry, the Government has
retained a sizeable holding of the shares of the privatized mines.
The global copper mining industry
operates with a long-term perspective, and production costs and risk are
critical issues. The nature of the industry requires high upfront investment,
high risk and long payback periods, and this has a number of implications (see
below). Production costs can differ significantly between mines, depending on
the type of mine and nature of the deposit. In the mining and refining
industries, with prices determined by international markets, the key determinants
of competitiveness are the costs of production and transporting product to market.
A mine’s cost of production is a function of the nature of the resource (the
quality of the ore, its depth, etc.) and the extent to which the most accessible
resources have been exploited. The depletion of resources at the older mines
means that they now need to mine at considerable depth and distance from the
mine head, leading to high costs. Younger mines can save on operating costs,
but they have to bear the upfront investment in capital and equipment, which
can be significant. In addition, the cost and productivity of inputs influence
the cost of production at all mines, irrespective of the nature of the
resource. If prices are reasonably attractive, the cost of inputs low and the
productivity of inputs high, even older mines can earn profits. For transport
costs, location relative to processing and refining facilities is the key
driver of costs. The overall business environment in which the mine operates
also affects costs.
Potential for Zambia
Zambia is recognized
internationally as having good mineral potential. The Fraser Institute’s highly
respected survey of mining and exploration companies ranks Zambia 26th out of
79 jurisdictions worldwide for mineral potential. In Africa, only the
Democratic Republic of the Congo and Burkina Faso have an appreciably higher
score for mineral potential. The resources available to existing mines in Zambia
are estimated at 2.8 billion tonnes of ore ranging between 0.6 percent and 4
percent copper. This, together with recent successful exploration, should be
sufficient to sustain even an expanded industry well into the middle of the
twenty-first century. Global demand for copper is expected to remain strong.
Long-term forecasts are by nature uncertain, but global demand for copper is
expected to grow at around 3 percent annually, reaching 25 million tonnes by
2020. Much of the increase in demand will be driven by economic growth and urbanization
in emerging economies, especially China and India. Limited global supply should
support high (but volatile) prices and continued investment. Global supply of
copper from known sources is expected to peak at 20 million tonnes by 2013/14
and decline thereafter, resulting in a shortfall in supply. As a result, copper
prices are expected to remain high in real terms, though they will be subject
to cyclical fluctuations and periodic, short-term volatility. To meet the
shortfall in supply and to take advantage of high prices, the global mining
industry is looking to increase investment in copper mining and refining. Good
mineral potential, combined with strong demand in the global market, provide an
excellent opportunity for growth in Zambia’s copper mining industry. Assuming other
conditions are right (e.g. Zambia’s mines are competitive in terms of costs and
productivity levels), Zambia can capitalize on its mineral potential as well as
the strong demand for copper in the global market.
Cost Structure
Production costs are high, driven
by high (and rising) input costs and low productivity. The Zambian mining
industry has a high cost base. Nearly all operations in Zambia are in the top
half of the international cost curve (see Figure below). Many of the older
mines, which account for the majority of output, are in the upper quartile of
the cost curve. The newer mines have lower costs but are still in the middle of
the curve. The major input cost of concern is labor, which has risen dramatically
in recent years and the productivity of which is well below international
standards. The cost of other inputs, such as equipment, spares, fuel and other
consumables is also high.
Exploration
Better availability and quality
of geological survey information could facilitate new mining investment. With
as much as 40 percent of the country remaining to be surveyed, it is impossible
to state with precision the size and economic potential of additional copper
reserves in Zambia. Without high quality and detailed survey data upon which to
base exploration decisions, potential investors face greater uncertainty and
must proceed on a speculative basis. Investor uncertainty is ultimately reflected
in the price they are willing to pay for a license, compromising Zambia’s
ability to get appropriate value for money from exploration licenses. While
some data are available, the quality and level of specificity is often not
sufficient to support exploration. In addition, information is often not easy
to access from abroad. Higher quality and more easily available survey data are
likely to attract more investment and lead to development agreements that
deliver better outcomes for the Government, the mines, and the Zambian people.
The cost of electric power from
the public grid in Zambia (US$0.04-0.06 per kWh) is among the lowest in the
world. Periodic outages, however, are a concern for power-intensive industries
like mining and refining due to the sometimes lengthy disruptions to production.
Should the country again suffer frequent electric power outages as it did in
2008, mines would have to rely on a combination of grid power and costly
standby diesel generation (US$0.32-0.40 per kWh), making the cost of electric power
uncompetitive compared to countries with reliable supply from the grid. Even
more important is the capacity of the grid to accommodate planned growth in
production. Without a 40 percent or more increase in supply, availability of
electricity may be the binding constraint on whether and when the industry
reaches the 1 million tonne target. Assuming a constant intensity of electric
power demand, the target of 1 million tonnes is likely to be achievable only
when the Kafue Gorge Lower project comes on-stream in 2016. In addition, as the
industry expands to new parts of the country, there is a need to extend the
grid.
Greater labor productivity could
improve cost competitiveness. Low labor productivity is driven, on the one
hand, by increasing labor costs and, on the other, by low output per worker.
For example, at Mopani, labor costs increased almost fourfold between 2003 and
2008, and now comprise just over 40 percent of costs, compared with 22 percent
at Indonesia’s Grasberg mine. This is despite the fact that mining is not a
labor-intensive industry. Adversarial wage bargaining and Government and social
pressure has encouraged large wage increases for “insiders” (trade union
members) at the expense of restricting employment opportunities for the large
number of unemployed Zambians (“outsiders”).
Labor productivity is a larger
concern, and in this regard Zambia lags well behind international standards. In
Chile, annual production of copper per worker is almost seven times greater
than in Zambia, and a difference of this magnitude cannot be explained solely
by variables like scale, nature of resources and better equipment. Low
productivity is in large part driven by gaps in workers’ skills that are rooted
in weak technical and vocational training from industry and training
institutions.
More competitive,
locally-produced goods and services could reduce mines’ supply costs.
Manufactured goods, equipment and consumables are expensive and/or difficult to
obtain in Zambia; hence mines rely heavily on imports from South Africa and
elsewhere. Due to the logistics costs, trade facilitation fees and markups
associated with imports, equipment and spare parts in Zambia can cost more than
twice what they would in other countries. Motivated by profit, mines are keen
to source from the least-cost providers that can meet their standards of
quality, quantity and reliability. The greater use of local manufacturers could
theoretically reduce the import and logistics-related costs that mines currently
incur. Local manufacturers, however, lack the capacity to deliver the more
complex, high value- added products that account for the majority of mines’
spending at a sufficient quality to meet the needs of the mines. International
mine suppliers, who can produce the required quality, have thus far not located
in Zambia due to its lack of attractiveness for manufacturing and, until
recently, insufficient demand from mines. As a result, the industry buys only
low-value items (such as food, clothing, and non-critical services) locally,
often from traders rather than local manufacturers. Developing a high-quality,
high-value-added manufacturing base in Zambia that is capable of supplying
reliably a number of key products to the mines, will take time and will likely
not be feasible for all types of mine supplies. Nevertheless, a more efficient
local manufacturing industry could ultimately reduce input costs for the mines,
improve industry competitiveness over the longer term, raise the incomes of
local producers, and, potentially, help create markets for the copper
fabrication industry.
Transport
Almost all of Zambia’s copper is
ultimately exported, exiting Zambia along the routes of the North-South
Corridor which connects the Copperbelt province with the major ports of Durban
in South Africa (2,600 km) and Dar es Salaam in Tanzania (1,800 km). Due to the
weight and volume of copper and, in many cases, long transport distances to
port, rail—which tends to be lower cost than road transport—is the preferred
mode of transport in the copper industry worldwide. In Zambia, however, the
railway that links the Copperbelt to Dar es Salaam and Durban commands a very
limited market share. Privatization has not brought the investment and skills
needed to revive a rail system that fell into disrepair under public ownership,
and the system has not been extended to new mining areas. In contrast, the trucking
companies that, in the absence of an effective rail system, carry the vast
majority of Zambian copper to market, are relatively price competitive despite
significant inefficiencies along the corridor. Trucking companies interviewed
during the course of this study charge around 4.2 cents/tkm for southbound
traffic from the Copperbelt to Durban and 6.7 cents/tkm for northbound traffic.
The southbound price compares favorably with many other African transport
corridors and countries such as China and France (5.0 cents/tkm). However, the
trucking of copper does face a number of challenges that unnecessarily increase
costs and transit times. Aside from inefficiencies related to border crossings
(described below) the main inefficiencies in the logistics environment are
related to high fuel prices, poor conditions on some road stretches, and the
risk of theft of cargo.
Regulatory Environment
A new regulatory and tax regime
that balanced the interests of the industry and the country could create a
‘win-win’ situation. At the root of the disagreements over the tax regime is
the inability of the Government and industry to find an equitable balance
between, on the one hand, the commercial interests of the industry and, on the
other, the industry’s contribution to national prosperity. Such a regime needs
to cover, in a clear and transparent fashion, taxation, as well as Government’s
obligations to provide the macro stability, governance, infrastructure and
social services that the industry needs to prosper. In exchange, the Government
and public at large need assurances that the mines are in fact contributing
sufficient tax revenues to support the communities within which they operate
and at levels consistent with profits they receive from extracting Zambia’s natural
resources. Unless such a regime is agreed upon, the industry will continue to
dispute at least some aspects of the new tax regime and the growth of government
revenues will be constrained. Moreover, the regime will remain unstable,
thereby undermining investor confidence. A more predictable regulatory
environment could increase stability and reduce risks for investors. Given the
large upfront investments, long-term commitments and long investment payback
horizons inherent in the mining industry, stable and predictable policies are essential
in evaluating a mining project’s perceived risks and economic viability.
Frequent legal and regulatory changes create an air of uncertainty for
investors. Zambia’s recent history of regulatory changes (such as has been seen
in relation to taxation, as discussed earlier) is a severe constraint on both
new investment as well as the continued operation of established mines. Responsibility
for the delivery of social services could be transferred to the Government and
supported by appropriate tax contributions from mines. In Zambia, expectations
for the social contribution of mines extend well beyond those typically borne
by private industry. Zambian mining companies incur costs and responsibilities
associated with operating schools, hospitals and clinics, and maintaining local
road infrastructure. Mines serve these roles partly due to gaps in government
provision but in large part due to legacy expectations of mines that developed
prior to privatization. While in financial terms these costs are relatively
minor, uncertainty and lack of clarity under the current arrangement is cited
as a key deterrent to greater investment in the sector. Hence, there may be a need
for a more explicit agreement with the Government and the public at large on an
appropriate allocation of social provision responsibilities, with the
Government taking greater responsibility for supplying the services and a shared
understanding that the industry contributes its part through the tax revenues
it provides to the Government. Such an understanding would have to be supported
by mechanisms to ensure appropriate tax compliance and payment by industry.
References
F. McMahon and M. Cervantes for
The Fraser Institute. April 2010. Survey of Mining Companies 2009/10.
Michael Engman. May 2010. The
Role of Trade and Transport Issues in the Competitiveness of Zambia’s Copper
Industry (draft)).
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