Steve Todoruk joined Sprott Global Resource Investments Ltd. as a Senior Investment Executive in 2003. His views have appeared frequently in Sprott’s Thoughts. His insights into the mining industry – where he worked for nearly two decades before joining Sprott – are useful to anyone new to investing in the sector. He recently spoke with me about rising risk from political authorities.
Political risk can be an especially unpredictable component in the analysis of a stock, but one that is ignored at an investor’s peril. As a mining project advances, we can make projections about how certain engineering or construction delays or cost over runs might affect that project.We cannot, however, calculate the impact of political risk events. And that is a major problem for investors when it comes to investing in the junior mining exploration stocks.
As metals prices have risen over the past 12 years, human greed has reared its ugly head.
A common potential scenario is as follows:
A potentially lucrative gold deposit is discovered in a revenue seeking country. The mining company that owns the project promotes its value to shareholders and mining analysts. This has the effect of attracting the attention of governments, citizens and NGOs (Non-Governmental Organizations) – all wanting a piece of the pie.
One recent example of this pattern is Lydian International, a well-known junior company claiming to have a very high-grade and sizeable gold deposit in Armenia. The government of Armenia recently halted construction at the Amulsar gold deposit pending review of its building permits.
A hold like this has a serious impact, especially this late in a project when the bulk of the capital has already been deployed. The market suspects that the government will use this fact as a bargaining chip to force more taxes and royalties to be paid by the company.
This also deters further investment in the country – if they’ve played these games once, there is a good chance they will try to do so again.
The damage to this project has been done and will be long-lasting. Unfortunately, in these poorer countries, the government doesn’t think their actions through. An apparently short-sighted decision can seriously detract international investment that would help grow their economies.
I recently talked about Kinross Gold Corp.’s decision to walk away from and write off their coveted, world class Fruta del Norte gold deposit in Ecuador. That country’s government fervently demanded unrealistically high windfall taxes on the mine Kinross wanted to build. Although the mine will likely be taken over by Codelco or a Chinese group, Ecuador has killed any hope that North American or Western mining companies will invest there significantly in the future.
Back in 2003[1], a well-known Canadian junior named Nevsun Resources made a fabulous new gold, copper and zinc discovery in Eritrea. The stock was flying high from the early days of their discovery and the first couple years of this project. The project advanced and everyone — including the Eritrean government — could see how valuable this deposit was becoming. Once the company had grown the value of the deposit through exploration, the Eritrean government ordered Nevsun to cease all further work on their project pending clarification of some permits and misunderstandings.
Nevsun went on to build the deposit into a mine. But they had to do so the hard way, on their own. No bigger mining company would take over Nevsun for fear that the Eritrean government would change its terms or place further holds on the property. A company such as Nevsun will trade at a lower premium than it would if it were located in a safer jurisdiction — even if they never have any more problems.
I believe that Lydian ran into a similar fate. This company was a top takeover target for a big gold mining company. As with Nevsun, their chances of being taken over have been slashed. This means that the little company could end up having to build and operate the mine on its own, which is not the optimal outcome for its shareholders.
In my opinion, the jurisdictions currently with the most “mining-friendly” political and social environments are Canada, Nevada, Mexico, parts of Australia, West Africa (Burkino Faso and Ghana) and some of South America.
Note that being “rich” does not make a country pro-mining. “Developing” countries often rely more heavily on mining revenue. As a result, it is often easier to obtain permitting and start a mine than in places where mining is of little historic importance and has relatively little social awareness.
If you are going to invest in politically riskier (from an extractive industry perspective) jurisdictions – places such as the Congo, or California, for example – be aware that political risk is a very real threat to mining companies and their share prices.
Steve Todorukworked as a field geologist for major and junior mining exploration companies after he graduated with a B. Sc. in Geology from the University of British Columbia, in 1985. Steve joined Sprott Global Resource Investments Ltd. in 2003 as a Senior Investment Executive. To contact Steve, e-mail him atstodoruk@sprottglobal.comor call him at 1.800.477.7853.
Read online > By Henry Bonner (hbonner@sprottglobal.com)
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Not so for Arizona'c ase but certainly Indonesia is one of those countries. FCX owns 5 of 12 or 14 mines in Arizona's Copper Alley. You'd think given their experience in the Congo DRC, Indonesia versus Arizona, that they more than anyone, might take the tme to learn of new opportunities in more politically stable locations. .
Higher Royalties
Indonesia’s government has been pushing metal mining companies in the country, including Freeport and Vale SA, to raise the royalties they pay to 10 percent, as part of negotiations to extend the companies’ mining contracts.
Freeport has agreed to raise royalties for copper to 4 percent from 3.5 percent, for gold to 3.75 percent from 1 percent, and for silver to 3.25 percent from 1 percent, Soetjipto said.
The government is also seeking higher state revenues from the mining industry by increasing domestic metals processing to lift the value of shipments. It plans to ban all mineral-ore exports starting from 2014.
Freeport will still be allowed to export concentrates in 2014 as the company is committed to developing domestic metal processing, Soetjipto said.
“I don’t expect that there will be a drastic decision by the government,” Soetjipto said. “And so far from our understanding, the government agrees to give us hopefully some time for us to still continue exporting our concentrate.”
Freeport exports about 60 percent of its concentrates and the rest of its output is processed atPT Smelting, Indonesia’s only copper smelter, he said.
Freeport will sign concentrate-supply agreements with three companies that plan to build smelters and is conducting a feasibility study to build a processing plant in the country, Soetjipto said. The smelters, which are expected to be completed by 2017, will need supplies of as much as 1.6 million tons of concentrates to produce a total of 500,000 tons of copper cathode, said Rudy Seba, Freeport’s Vice President of Technical Affairs.