Assessing the implications of political context on the viability of SADC coal projects

1. Assessing the implications of political context on the viability of SADC coal projects Claude Baissac, Eunomix

2. About Eunomix May 2013

3. Key definitions:Country risk • Eunomix defines it as the exposure of one’s employees, assets, operations, reputation and strategic objectives to individual and systemic risks that originate from its countries of operation • Country risk encompasses political, economic, and social risks. It is a manifestation of structural factors (regime type, governance, national wealth, economic system, social capital, international position) as well as of the actions of national actors and groups of actors May 2013

4. Key definitions:Political risk • Political risk is the exposure of employees, communities, assets, operations, reputation and strategic objectives to individual and systemic risks that originate from political actions and events within and outside of countries where one has operations or investments • It arises from regime type, policy, and the actions of non-governmental actors (parties, media, unions, communities, etc.) that seek to achieve political objectives in the broad sense, and from non-economic events that arise from these actions (consequences) and other factors (externalities) May 2013

5. Key definition:Issue fungibility • In practice, it is often difficult to precisely identify whether a risk is political or country, domestic or foreign. Causes are often complex, multiple, and non-transparent. In an integrated world, issues are fungible, events are cross-border in causes, manifestation, and impact. The world is complex, and increasingly so • For this reason, we speak about political and country risk as one subject matter. But even that broad construct is potentially reductive. It must be used as a way to organise one’s risk exposure, but will never be fool proof May 2013

6. Taking stock:Economic opening and political stabilisation • Together with the rest of Africa, SADC has experienced an economic and political turnaround since the late 1990s • It is more opened, more stable, more peaceful and more prosperous than ever • The national liberation struggles, which scarred the region for longer than anywhere else in the continent, have been resolved • Democracy, cooperation and regional integration are realities that individual crises and exceptions cannot erase or reverse May 2013

7. Taking stock:Faster growth and improved economic stability • The SADC region has benefited from a “liberation dividend” that is expressed through higher economic growth: nearly 6% in 2010 and 4% in the 2000s. Without Zimbabwe, growth would have reached 4.7% • This compares favourably from the difficult decades of the 1980s (3.3%) and 1990s (2.9%) • Higher growth and improved policies have led to significant gains in key macroeconomic indicators: government debt is was to about 40% in 2011 from 80% in 2004 May 2013

8. Taking stock:Changed trade and investment patterns • SADC country increasingly trade with one another. Out of exports in goods of $100 billion, $40 were intra-SADC in 2010, a 17% growth from 2009 • Trade with Asia has also grown rapidly, and represented 45% of imports and exports for 2000-2010 • The growth of FDI has been spectacular: from less than $5 billion in 1998 to a peak of nearly $35 in 2008 • There too, the growing role of Asia has been a decisive factor May 2013

9. Taking stock:Political and country risks remain significant • Progress remains comparatively slow, notably when looking at the Eastern African situation • There remain significant disruptions in country stability – the DRC, Madagascar and Zimbabwe • Despite progress, SADC countries remain bottom performers in Doing Business • Similarly, as a whole the region ranks relatively poorly in political risk rankings May 2013

10. Taking stock:Poor Doing Business performance May 2013

11. Taking stock:Moderate political risk, with some dark spots – the Aon Political Risk Map May 2013

12. Taking stock:Below average investors perception of the region’s policy potential – the Frasier Institute Policy Potential Index May 2013

13. Regional mining risks:Increasing social demands • Social scrutiny at the local and global levels are rising • At the local level, communities are expecting greater inclusion, access to jobs and economic development, greater compensation, and lower negative impact • At the global level, there is rising pressure for transparency and human (EITI, Equator Principles), regulatory oversight, (Dodd-Frank, UK ABA, etc.) and compliance. • But players are not equal in this, with Western-listed companies under greater obligations than non-listed and non-Western ones May 2013

14. Regional mining risks:Regulatory uncertainty, poor transparency • One of the key risks is the continuing lack of regulatory certainty, with the return of “resource nationalism” • Key issues have been the introduction or consideration of free carries, regulated local participation, royalty taxes, resource rent taxes, export controls and/or taxes, contract reviews and renegotiations, and the likes • Licensing remains on the whole discretionary, non-transparent, and in some cases fundamentally corrupt May 2013

15. Regional mining risks:Scarce and costly infrastructure • Infrastructure – ports, rail and road; power; water supply; etc. – remain scarce, poorly functioning and costly • Infrastructure policy has made notable progress, and transport corridors are emerging • New funding and development models – notably PPPs – are delivering, but often fail to deliver broad economic benefits because they are too narrowly focused on specific projects • But policy remains dogged by poor formulation and implementation capacity, and lack of funding capabilities May 2013

16. Regional mining risks:Rising costs in an unstable market • Cost inflation has affected mining across the region, with in some countries double digit year or year escalation • Main cost items have been energy, transport and labor • We view this cost inflation partly as a manifestation of political and country risk, because they tend to be policy-driven – the result of delayed planning, poor implementation, lack of competition, and burdensome regulation • This cost inflation has had a detrimental impact on profitability as commodity prices are under pressure May 2013

17. Regional mining risks:Governments still behaving as if boom is here • We recently completed a 40 year analysis of the relationship between resource rents, prices and growth – available on www.eunomix.com • It conclusively shows that African governments have generally applied the wrong policies at the wrong time: pro-market in commodity up-cycles and nationalistic in down-cycles • As a result, governments tend to undermine investment, growth and rent formation • The current situation is case study in this May 2013

18. Regional mining risks:The counter-cycle policy curve Prices Mineral rent May 2013

19. Impact of country risk:The flight to safety • With increasing costs and decreasing returns, higher risk countries are less attractive than they were in 2011-2012 • The risks highlighted previously were seen during the super-cycle as issues that money and energy could resolve • Today these risks are not just issues, they are deal-breakers in a flight for certainty and cost efficiency • This is evident from the lower number of deals occurring, and from the retreat of both majors and juniors from many countries May 2013

20. Impact of country risk:Taking opportunity • The flight to safety is opening opportunity for many. One’s risk is someone else’s opportunity • While governments are still intent on increasing state participation, lowered investment is opening the space for constructive engagement • Mining companies who take the opportunity should develop a partnership-based approach to political and country risk management May 2013

21. Impact of country risk:Taking opportunity • The flight to safety is opening opportunity for many. One’s risk is someone else’s opportunity • While governments are still intent on increasing state participation, lowered investment is opening the space for constructive engagement • Mining companies who take the opportunity should develop a partnership-based approach to political and country risk management May 2013

22. Taking opportunity:Risks go both way • Countries and communities hope that projects will bring them significant benefits in jobs, local economic opportunity, tax revenues, export earnings, and so on • They are also concerned about the many negatives: expropriation, loss of access to land, environmental damage, insecurity, diseases, political interference, social change, corruption, and so on • Mining has often proven to be a curse to these societies – both nationally and locally May 2013

23. Proactive risk management:Cameroon case study • Root country risk management as a strategic commitment, and communicate this effectively, internally and externally • Develop the knowledge and risk management system to effect greater country risk resiliency • Leverage country risk management to improve the company’s political and social licence to operate • Increase the company’s value through the effective de-risking of key exposures in a transparent, effectively communicated way May 2013

24. Proactive risk management:Cameroon case study • Problem: lack of initial clarity for stakeholders on project’s goals, configuration, timeline and expected benefits • Consequence: passive resistance to exploration program at the ministerial level • Problem: lack of understanding of all required permits and licenses – notably in sensitive environmental areas • Consequence: delay in exploration start and poor initial perception of the company within key ministries and international orgs

25. Proactive risk management:Cameroon case study • Problem: over-reliance on local partners and personnel for stakeholder engagement • Consequence: capture by legacy issues and vested interests not always aligned with the company’s objectives, interests and plans • Problem: constrained access to infrastructure by first mover • Consequence: limited options for product exports, with higher cost May 2013

26. Proactive risk management:Cameroon case study • Greater clarity on country’s “stability trajectory”, and therefore on the window of opportunity and investment horizon • Better understanding by the company of the connection between its activities and local social, economic and security outcomes • Better understanding by stakeholders of goals and horizons • Significantly improved relations with key ministries and international organisations May 2013

27. Proactive risk management:Cameroon case study • Development and implementation of best practices in: • Community engagement and compensation • Access to sensitive forestry areas • Lower operational footprint and negative local impact • Operational security • The company is now a formal participant in transport infrastructure development strategy and planning May 2013