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Sunday, 29 March 2009

WSJ : Zambia's Copper Meltdown


  1. The reporter there points out that "the Zambian government gave lucrative mining deals to foreign investors at the expense of the locals and now the Zambian public are paying the price."

    That is true, but to be fair to the Zambian authorities, they did attempt to introduce windfall taxes on the mining firms, albeit a bit too late, and amid opposition from the likes of ZIPPA, in particular Murray Sanderson.

    Would ZIPPA and it's representatives care to explain to the people of Luanshya, featured in that interview, what benefits their arguments have brought?

  2. Luanshya mine is a high cost operation due to the low grade ore it has. Therefore mining companies need to be given incentives to run it. In a time of low copper prices it will make a loss no matter who runs it.;col1

  3. The incentives were given to ALL foreign owned mining companies, not just those operating Luanshya mine. Now most have reaped their enormous profits when copper prices rocketed, with little tax paid to the Zambian government.

    Yes, in general mining profitably is difficult when metal prices have slumped. But my point is drawing attention to what happened in the good times.

    You may have heard the Chilean President Michelle Bachelet telling the whole of the UK PM, in his face, that her country saved for these bad times.

  4. Chile and Zambia cannot be compared. Chile established its copper stabilization fund in 1986 and had many years to accumulate financial reserves. In Zambia the mines were run down under state ownership and had to be privatized to attract investment for rehabilitation and expansion.

  5. Kafue,

    You make an interesting point about the cost of production being variable from mine to mine. I am still hunting for cost data from Luanshya, but the BNET article you cited claims that Kansanshi and Lumwana are operating on similarly low grade ore deposits. First Quantum reported total cost of production at Kansanshi for 2007 to be US$1.04 per pound. Due to uranium extraction capacity, Equinox reports that Lumwana, "total life of project Operating Cash Costs under the Development Case are expected to be US$0.82 per pound or US$0.76 per pound of copper produced, inclusive of uranium credits." I believe that copper closed at US$1.89 today, however obviously not all of that can be captured by the producers as brokers and middlemen always take their share. That said, Luanshya production costs would have to be significantly higher than the other operators to actually prohibit profitability at current copper prices.

  6. Yakima,

    According to this article, Luanshya copper mine has been making losses of $5 million a month since last September. Maybe there are other factors involved.

  7. Kafue,

    I suspect that the actual shortfall is around US$5 million per year, as indicated by statements from Enya Holdings BV, from Jan 5 that losses were US$400,000 per month (US$4.8 million per year). The stated debt of US$98 million @ 7% would require US$6.86 million per year to service.

  8. Also in the article it says:

    "Luanshya Copper Mine owes shareholders about 80 Million US dollars, while creditors are owed 18 million US dollars"

    Fortunately the private sector is bearing this burden and not the State, if the State had been running the mine.

  9. Kafue,

    I am afraid that I must disagree with your characterization that, "the private sector is bearing this burden," as the vast majority of the company debt load is owed to its own shareholders. This is essentially a mechanism whereby the shareholders can continue to make money off the company operations even when the company is reporting operating losses. The real question is, why didn't the company raise this US$80 million dollars by selling more stock to these investors, instead of taking on interest bearing debt owed to themselves? Perhaps these are "concessionary loans" given at below market interest, but that presupposes that the same persons who invested in the mine in the first place still think that they can obtain a higher return from loans than from stock. Stock entails risk, and stockholders are typically the first money in, last money out, whereas bank creditors are able to collect even before labour. Suffice it to say that the phrase, "debt owed to stockholders," is not one that I am used to seeing outside of small family businesses (where the loaning entity often holds a single share of preferred stock, and is loaning to a family member who is the principal "owner"), and certainly not in publicly traded companies.

  10. Yakima,

    I don't understand how shareholders are continuing to make money off the company operations if the article says that shareholders are owed $80 million. Regardless of whether the shareholders own stock or make loans, if they don't receive payments from the company, they are still losing.

    It can also be seen in terms of opportunity cost, the shareholders could have invested or lent their money elsewhere and be earning income rather than receiving none as is the current case. Another situation is if the shareholders borrowed money to lend to the Luanshya mine. They would still be paying interest expense on their own debt, but receiving none from Luanshya mine (this could be the answer to your question as to why they did not buy stock - because they did not have their own funds, but borrowed it from elsewhere and lent it to the mine).

  11. Kafue,

    Well unless they are owed the money at 0% interest, then they are making money off the debt, no? If the company were to enter into receivership, then stockholders collect last, while creditors collect among the first. This is standard in bankruptcy arbitration. Stockholders are not owed anything, except for a per share declared dividend if such is indeed offered, but no company is required to pay dividends. There is no rational reason to loan money to a company without a mandated interest rate, otherwise it is not a loan, it is investment, with attendant risk. If a capitalist borrows money to buy a stock it is called margin and if the stock becomes worthless they are still liable for the margin loan. If a capitalist loans money to himself it is an accounting trick, which not coincidentally takes returns out of EBITDA, not out of share price increases based on net profits. Also not coincidence is the fact that the owners would like to sell their share in the mine, therefore don't want to water down the P/E ratio of the existing stock, for which they are unlikely to get a favourable price under the current circumstance, when they have a firm commitment for $80 million which will have to be assumed by the new owners at face value. It is smart, just not selfless.

  12. Yakima,

    Why do you assume the new owners will take over the debt of the new mine at face value? In receivership, the assets will be liquidated at whatever price that can be obtained unless there is a floor price set. So for example if it is liquidated at $20 million, then debt holders will lose $60 million.

  13. Kafue,

    If the mine goes into receivership then it means that they were unable to find a buyer for the intact company. In that circumstance, yes, creditors can lose money too, but if there is only $20 million in assets once all the equipment and other remaining tangible assets are auctioned off, then the creditors will get it all and the stockholders will get none (chances are the external creditors are first in line, so they will get $18m and the shareholder creditors only $2m). If there is $100 million, then the creditors will get their entire $98 million with $2 million left over as the net asset value of the stock. Why so keen to paint Enya Holdings BV in such a charitable light?

    Let me put it this way, the average return on stock investment for African mining operations over the last decade or so has been well above 15%, while the average interest rate paid to creditors is about half that. If they thought that the company would succeed, why would they want to cut their return in half by issuing a loan instead of demanding stock? On the other hand, if they thought that the company would fail, then they are far better off as creditors. The US government has been having similar negotiations with corporations seeking bailout funds, demanding that taxpayers have an opportunity to benefit from eventual upside gains equivalent to private shareholders in exchange for the risk of these companies failing in spite of the additional capital.

    So, if the shareholders knew that there were only $20 million in tangible assets in the event of liquidation, then they would have been fools to loan $80 million, since the company would have to turn a profit in order to pay them back, in which case they'd get a larger proportion of that as stockholders than as creditors. If on the other hand, they expect to sell the company with all assets and liabilities intact, then the new owners will have to find a way to pay back the $80 million loan with interest. This is hedging behaviour, not charity.

  14. Zedian writes "to be fair to the Zambian authorities, they did attempt to introduce windfall taxes on the mining firms, albeit a bit too late, and amid opposition from the likes of ZIPPA, in particular Murray Sanderson.

    "Would ZIPPA and its representatives care to explain to the people of Luanshya....what benefits their arguments have brought?"

    A number of points need to be made in reply:

    1. It would be good to know what statement Zedian has in mind. A quotation would be helpful.

    2. All issues of ZIPPA's journal end with the disclaimer "The views expressed in this journal are those of the authors. They are not necessarily shared by members or by ZIPPA, which has no official view." Views expressed by me on the blog are always signed 'Murray'.

    3. My personal views on the subject of agreements, whether with mining companies or with other investors, local or foreign, is that they are legally binding on the parties, including governments, even if one party should later conclude that it over-committed itself. To abrogate an agreement by passing a law in parliament is contrary to the rule of law, as was made clear in articles in ZIPPA's 3rd Qtr 2008 Journal on that theme, which Zedian can obtain from Chola. Abrogating agreements, by destroying trust, has a very adverse affect on the investment climate and consequently on economic development.

    4. As regards the interests of the people of Luanshya, the reopening of the mine, and the resulting employment over the last few years, were due to the investor's trust that the Zambia Government would honour the development agreement. Such trust will be much harder to win in future.


  15. Yakima,

    "Why so keen to paint Enya Holdings BV in such a charitable light? "

    Not at all. I am pointing out a possible future scenario which could occur.


    "So, if the shareholders knew that there were only $20 million in tangible assets in the event of liquidation, then they would have been fools to loan $80 million, since the company would have to turn a profit in order to pay them back, in which case they'd get a larger proportion of that as stockholders than as creditors."

    Not at all. Shareholders made their investment with the expectation that copper prices would remain high. When copper prices are low, the market value of assets becomes less because there is less demand for loss making assets. So a possible scenario that could occur is that the new buyers could refuse to assume the existing debt, similar to the situation when Anglo American bought their mine/s from the government:

    "Perhaps most critically, the state cut thousands of workers from the payrolls and assumed the reported $770 million in debt that ZCCM accumulated through years of low copper prices and flagging production."


  17. Murray,

    Just seen your response, many thanks. I shall be back soon.



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