Extractive Industry and Sustainable Development: The Institutional and Regulatory Challenge

1. Extractive Industry and Sustainable Development: The Institutional and Regulatory Challenge Perrine Toledano Lead Economics and Policy Researcher, Vale Columbia Center on Sustainable International Investment, www.vcc.columbia.edu April 29, 2013

2. VALE COLUMBIA CENTER ON SUSTAINABLE INTERNATIONAL INVESTMENT • Joint center of Columbia Law School and the Earth Institute (science-based research for sustainable development) at Columbia University • Mission: To develop and disseminate practical approaches and solutions to maximize the impact of international investment for sustainable development • Special Focus on Extractive Industry • Applied research center – developing research to serve our advisory work in resource-rich countries

3. Extractive Industries and Sustainable Development : WHY? • Special challenges and negative track records in extractive industry investments: • Deposits often in poor, unstable countries • Threat of the “resource curse” • Risk of enclave sectors • Historical records of human rights and environmental shortfalls • Confidentiality and asymmetry of information • Highly politicized at times • Potentially transformative opportunities: • 30-Y partners • Major infrastructure and supply chain needs with potential spill-over effects • Profitable projects while generating billions of dollars of revenue for governments • Increasing recognition that extractive industries can be a key driver for long-term growth Extractive industry investments can be win-win investments for governments, companies and communities…

4. A long-term perspective is needed … both for governments and for companies • Extractive industry investments have large upfront costs, and not profitable for several years • To maximize profit, extractive industries must: • ensure investment stability over the life of the mine • minimize costs over time • Gov. focus on attracting investment, boosting the numbers (GDP, FDI..), front-loaded taxes (bonuses, royalties) and political cycle • Opportunities to maximize is over the long term (when workforce is trained, when companies face the pure rent and have recovered capex, when the infrastructure is developed) In a context of changing legal environment, the “so-called resource nationalism” and confusion about the roles of extractive industries, both parties need a framework to think long-term!

5. At the VCC, we have developed this framework For Government it highlights the many areas in which mining investments can contribute to national development priorities For companies, it promotes stability and reduces political risk and unforeseen costs that result from an unstable deal The goal of all stakeholders is a mutually beneficial, long-term relationship, which enables the profitability of the industry as well as ensures that the investments translate into widespread development benefits for the population 

6. Framework for Extractive Industries and Sustainable Development We have identified five pillars that are essential for the long-term stability of an investment: 1- Legal and Fiscal Framework • A transparent legal and fiscal framework for extractive investments, mutually beneficial to industry and the host country. Profitability of the industry Widespread development benefits for the population • Medium-term planning, a public investment strategy, strategic resource management, and effective budgetary mechanisms and execution. 2- Planning and revenue management mechanisms 3- Economic integration, diversification policy • Leveraging the extractive industry investments for infrastructure expansion, vocational training, upstream and downstream linkages in line with development objectives. 5- Pillar framework 4-Local Development Strategy • An integrated development strategy to ensure that the population benefits from the extractive industries both during and beyond the life of the project. • Multi-stakeholder management of the cumulative environmental risks, impacts and challenges associated with resource extraction and development 5- Environmental management systems If the framework is not in place, the question of extraction of non-renewable resources is worth asking!

7. Pillar 1 – A Transparent and Mutually Beneficial Legal Framework for Extractive Industries Governments and companies can help promote a stable and predictable investment climate and minimize the risk of disputes through: Revenues and Contract Transparency to encourage a fair deal and clear allocation of responsibilities Achieving a balance between fiscal and non-fiscal benefits in legislation and contracts Use of innovative, flexible fiscal mechanismsthat self-adjust to market circumstances and avoid the need for tax reforms Increased capacity on auctioning, auditing, financial modeling and contract negotiation

8. Illustration: Disproving that transparency hurts valuation Disclosing on a country-by-country basis (only 17 companies in 2010)– what’s the fuss?

9. Pillar 2– Resource-based development planning and resource revenue management Governments and companies can avoid the ‘resource curse’ and ‘dutch disease’ and maximize the development impacts of extractive investments through: Medium to Long Term Development Strategy • Include medium-term plans • for infrastructure, linkages, domestic resource needs and environmental impacts • Coordinate donor and private sector activities with national development priorities • Align the budget with development priorities and plans • Identify public investment priorities with costs and implementation plans • Ensure budget transparency • (including of resource revenues) • National and regional development plans enable companies to support national priorities and coordinate with other public and private actors

10. Snapshot of Timor-Leste • Population: 1.1 million • Per capita GDP 2009: US$717 (PPP) • Stunting rate in children: 58% • Child mortality rate: 64/1000 • Children with malaria : 50% • Literacy rate (above 15 years old): 58% • Secondary school enrollment: 41% • More than US$2.172 billion was collected in petroleum revenues in 2010 • The balance of the Petroleum Fund is now over US$10 billion • In 2010, government drafted a Strategic Development Plan • The VCC helped to create an Infrastructure Fund and a Human Capacity Fund for increased, multi-year allocations to key sectors from the Petroleum Fund

11. Pillar 3– Leveraging the Mining Investments for Sustainable Development and ensuring linkages Country TRADITIONAL ENCLAVE MODEL 11

12. Pillar 3– Leveraging the EI investments for development : the mining investment in infrastructure – rail and ports 900 km – $3 bn Relevant for bulky commodities: iron-ore, coal , manganese, bauxite 2/3 of the capex!

13. Pillar 3– Leveraging the EI investments for development : opportunity to build the backbone infrastructure Corridor : Leveraging high volume, high cash flow / lower development impact such as mining to unlock the low volume, low cash flow/ higher development impact agriculture that cannot afford the backbone infrastructure Potential of Backbone infrastructure gets realized only if “shared-use” (multi-purpose/ multi-users) of the resource-infrastructure is implemented Very challenging given the natural monopoly of a mine investing in infrastructure

14. Pillar 3– Leveraging the EI investments for development : regulatory incentives for shared-use Regulatoryincentives FOR shared use

15. Pillar 3– Leveraging the EI investments for development : shared-use of power infrastructure

16. Pillar 3– Leveraging the EI investments for development : Chinese resource for infrastructure deals IS CHINA R4I A SOLUTION TO MULTI-USER? The DRC Model From 2007 to 2009 – $5Bn Chinese loans for infrastructure!

17. Pillar 3– Leveraging the EI investments for development : upstream and downstream linkages Often not in place!

18. Pillar 3– Leveraging the EI investments for development Liberia Government SME AND LOCAL WORKFORCE TRAINING PLAN over time!

19. Pillar 3– Leveraging the EI investments for development CHALLENGE OF REGULATIONS of LOCAL CONTENT • 1- Should a “local” company be defined by where it is registered, or by its ownership structure, its management, its staff complement, or a combination of these? • 2- How should the level of local content be compared between a locally owned importer/ distributor and a foreign-owned company that is manufacturing locally and sourcing its raw materials locally? • 3- Due to quality concerns of the mining company, how “competitive” should the local companies be? • 4- Are penalties efficient to enforce local content provision ? • 5- When shall a company plan for local content? Does this plan needs to be reviewed? WIDESPREAD and INCREASING USE OF LOCAL CONTENT REQUIREMETNS BUT OFTEN INEFFICIENT!

20. Pillar 4 – Integrated Rural Development (IRD) Local development plans to help companies identify appropriate and sustainable points of entry, to ensure companies are complementing, not replacing, local government • Example : Village-level IRD programs to address the integrated challenges of and opportunities for development • Example: Agri-business Alliance to support smallholder agriculture (extractives, agricultural extension services and food industries) CSR is not sustainable if it is not based on local understanding, holistic and transformative!

21. Pillar 5 – Managing Environmental and Climate Risks

22. SUMMARY: A new approach to sustainable investment in extractive industries should reflect the following: • Extractive Industry investments can be Win-Win investments for governments, companies and communities in the long term. • Projects can create critical investments in infrastructure, jobs in the supporting industries and be leveraged for the diversification of the economy. • Corporate Social Responsibility must be partnered with good governance: strategic medium-term planning, sound resource management, and effective partnerships. • At each stage, planning, transparency and cooperation in the process can help ensure positive results.

23. Some VCC ongoing projects • Local content: legal language to translate sound policy objectives into reality • Competitive bidding: why a rising trend? does it lead to tangible benefits? under which conditions? impacts of international treaties? • Investment treaties and investor-state disputes: impact on balance of rights and obligations between investors and states with regards to sustainable development • Business case for transparency in the context of companies’ backlash against Dodd-Frank application rules • Fiscal reforms in Extractive Industries: how to achieve stability and flexibility? Progressive fiscal regimes – any correlation to less renegotiations? • Periodic review mechanisms: efficient? in which sectors? under which conditions? influence of international treaties? • Capital gains: how to capture these gains arising from direct or indirect transfer of rights? • Resource-infrastructure for development: how to promote and implement shared use of resource-infrastructure • Employment impact of mining: myths and realities • Strategic environmental assessment: how to upstream and mainstream environmental protection in the pre-contracting phase • Negotiation support for developing country governments: how can comprehensive support be made available?