Overseas Investment in Mining - Key Challenges - My article in the CII Journal of Manufacturing Excellence

Rush to Capture: Resources sector has been dominant in the mergers and acquisitions market even while the broader markets are emerging out of the recent financial crisis. The rush for mineral assets ranging from coal to iron ore and from copper to potash are largely being ascribed to economic growth expected in the emerging markets, more noticeably in China and India. Naturally, the Chinese and Indian companies have been in the race to grab global mineral resources, and the large Chinese acquisitions have alerted the mining companies and governments alike. Indian mining sector participants have been more cautious in their deal making and a significant proportion of the reported overseas acquisitions in mining sector have been done by the private sector, which is in contrast to Chinese largely state-owned enterprises led acquisitions. In a Deloitte-Mergermarket Group survey of Chinese mining sector conducted in August 2010, a combined 73% of the respondents expected the deal making in mining sector to increase. That sure indicates the nature of developments in the times to come.


Rationale Behind: The primary reason for overseas investments for Indian utilities, mining and metals companies have been to tie their raw material sources. The slower than expected reforms in India have resulted in lower investments and hence, project developments in the domestic industry that have led to serious supply constraints. While production of coal and other minerals has increased, it has not been able to keep pace with the demand. This unmet demand has hit the global markets and has had destabilizing impacts. Prices have increased to all-time highs and do not seem cooling. Consequently, the margins of the steel and other metals manufacturers that have sourced raw materials from the market have come under pressure, while the utilities have faced hurdles in financial closure and project initiation, due to uncertainty in raw materials/fuel supply. The backward integration to mining, therefore, has no longer remained an option for the downstream players whereas the miners have seen their profitability soar. The mining companies have cash pools and are willing to expand their resource bases to be able to cater to the domestic market demand.

Challenges Galore: Destinations of the overseas investments in mining have been largely Indonesia, South Africa, Australia, and some other the emerging markets although there are instances of investments in Canada, USA, and some Latin American countries. Mineral rich matured markets like Canada and Australia offer stable regulatory and statutory environment and access to well-developed financial and mining-services markets. On the other hand, Indonesia has introduced far-reaching changes since January 2010 through the new mining law and its implementing regulations. South Africa has also seen domestic demand spur which is likely to result in export controls, which is widely being advocated in the country. The country also has compliance requirements for Black Economic Empowerment rules, which restrict ownerships and hence, management controls.

While Indian investors have not shied away from picking stakes in mineral assets wherever they could, the challenges are being faced in implementing projects. Significant political risks exist, for example in Russia and Bolivia due to continued expropriations and nationalizations of companies and projects, and in forms of government interventions.

Many countries, particularly the emerging ones, have labyrinthine processes for clearances and approvals. Even in the developed economies, for example in the USA, regulatory frameworks pertaining to mountain-top mining have made delays commonplace. These are tougher to negotiate for foreign investors, who are perceived as neo-colonialists interested only in exploitation of natural resources of the host countries.

Taxation of mining products remains knotty issue. Australia witnessed a tug-of-war between the government and the industry on mining super-profit taxation. With the commodity prices rising, governments tend to consider windfall profit taxes. These combined with import duties on equipment and supplies, several levies, excise duties and royalties may enhance cost of production. Cash flows to equity investments also get impacted by the withholding taxes imposed on dividend repatriations.

Added to the taxation issues are the stability of local currencies and US dollar. The economic uncertainties of the US and the distortions due to suppressed Chinese Yuan have increased the foreign exchange risks of investments for raw material sourcing. Currency fluctuations have the potential to turn mining investments unviable and need active management and monitoring.

Sustainability and social license to mine are being talked about across the globe. Like in India, these may delay or cause cost overruns in mining development and sometimes, significantly erode the benefits of mine-ownership. Adherence to sustainability best practices are also mandated for financing the projects as the World Bank Group and equator-principle banks refrain from lending to non-compliant companies and projects. The African and many other countries desire to allow mining as a vehicle for social development and that results in burdens on the projects that go beyond the statutory obligations.

There may be challenges even at the operational levels. Countries impose restrictions on sourcing and procurements. Indonesia has recently regulated use of contract miners and has made mine-owners’ direct participation in coal winning mandatory. For most other procurements, the country requires tendering process and preference to local suppliers.

Most countries have varying degree of restrictions on employment of expatriates. Securing talent and retaining them can be a challenge in overseas investments. The labor costs have been witnessed to rise sharply with advent of foreign investors in African and South-East Asian countries. Geologists and mining engineers of comparable competencies are difficult to get in the host countries and to relocate Indian resources abroad may be expensive.

The Way Ahead: While it does make sense to invest in mining projects abroad, considering the scarcity of domestic sources and high global market prices, there are huge challenges that need to be overcome to make investment a success. Weaving these challenges in the strategic decision-making process will support prudent investment decisions. There is a need to go abroad with enhanced sensitivity to local aspirations and factor them into the cost estimates to assess cash flows and returns. Sans these, investment in mining overseas may lead to untapped potential and coveted minerals remaining in-situ.

*Dipesh Dipu is director in mining sector consulting practice of Deloitte Touche Tohmatsu India Pvt. Ltd. He can be reached at ddipu@deloitte.com.