Here is a conundrum :Editor’s note: This is a guest post by Ntheye Lungu, an analyst and regular contributor to the ZE Facebook page discussions.
You are a shrewd and very successful businessman. You started off in the mining supply business, before venturing into micro-lending where you made an absolute fortune charging your desperate clients outrageously high interest rates. Over the years, business has been incredible and you now find yourself with excess cash that you would like to invest in other ventures.
It has always fascinated you that although your country is endowed with substantial mineral resources, there are not that many local entrepreneurs who actually own and manage a substantial share of the mining enterprises. The major players involved in mining in your country are all foreign, all largely managed by expatriates (although you are fully aware that the labourers are predominantly local).
It has always struck you that in other countries endowed with mineral resources, there is always a local entrepreneur who has made a vast fortune from investing in mining operations, but this is not the case in your country. You surmise that you could be that local citizen to break the mould and become the first homegrown mining magnate. The thought of it, gets you very excited -- almost giddy!
Your street smarts, rather than any academic credentials (of which you have none worth touting), are what you consider to be the most valuable asset that has enabled you to make a success of your business thus far. However, your incredible business instincts tell you mining is unlike any other business you have ventured into previously, so you decide to seek some advise. You remember that an old classmate, who was one of the brightest in your time at school, now runs her own investment advisory firm. So, before making any rush decisions, you decide to meet with her over dinner to explore a bit further your newly found dream to invest in copper mining.
During dinner and after you have explained your thoughts, she says the following:
"Firstly, I will have to assess your specific requirements more formally with my team of experts in mining investments before I can give you a detailed view on this. However, there are a few considerations perhaps worth exploring from your perspective. For a start, copper mining is an incredibly capital intensive business. If you are considering a greenfield copper mine, be it open pit or underground, you should expect to make a substantial investment in construction works as well as equipment -- the type of costs that cannot be recovered easily by sale or transfer, so your commitment must be long term. It is not unusual, these days, for mining companies to invest well above US$10,000 to build capacity to produce a tonne of copper ore on new mines. For perspective, if you were looking at opening a mine the size of KCM whose current production capacity is reported at 160,000 tonnes, you would be looking at a conservative investment of US$1.6 billion to build that sort of capacity. Of course, the capital requirements all depend on the unique circumstances of your mine, such as depth of the ore body, grade of the ore, proximity to infrastructure like transport, electricity, etc. In addition to your up front capital injection, you will also have to consider how you will fund the day-to-day operations of the mine, like labour, fuel, electricity and other consumables, at least until the mine becomes self sustaining."
She goes on, "currently, copper prices appear to be closely linked with economic activity in China, which consumes nearly half of the global production of copper. The price of copper price, like that of all other commodities, tend to fluctuate depending on a series of factors -- demand from China being one of those factors. Over time, you can expect these fluctuations, which in your case would mean having the flexibility to cut your costs when copper prices are low. The easiest cost to reduce, usually, is labour. However, if you have followed media reports, the government has absolutely no appetite for shedding staff as a cost cutting measure -- you risk losing your mining license if you considered such a move. You may have to do with high operational costs, even when copper prices deep."
She further explains, "depending on how much mining capacity you build, you have to consider how you will sell the copper. If you intend refining the copper locally, you may need to look at where you will be having the copper refined. Exporting unprocessed copper attracts an export duty of 10%, which is could easily cut very deeply into your margins. You would have to consider processing locally, but there just isn't enough capacity, plus you would also have to consider the added costs of logistics. That is, you would have to transport the unprocessed concentrates to a refinery -- wait for the processing before exporting it, all while you continue to incur operational costs.
Finally, she adds, "there's also an uncertain outlook on the tax regime overall. The 10% export duty was introduced last year, suspended this year and re-instated again this year. There had been a mining windfall tax introduced in 2008, suspended in 2009, but the talk of re-introducing it is never too far from politicians mouths. Both these taxes I have mentioned here, exclude the mineral royalties, corporate and variable profit taxes you would have to pay on your margins. When you look at taxes, one thing you may want to consider -- if you have a long-term view -- is the current budget deficit in the country, sitting at 8.5% for 2013. Whilst seemingly unrelated to mining, if the budget deficits are not controlled, they may have the long term effect of resulting in inevitably higher taxes, beginning with the mining industry. So there's a lot to consider, but as I mentioned, I will have to assess your specific requirements more formally with my team of experts in mining investments. Let's take it from there..."
All the while you have been listening very intently to these explanations.
Are you still as excited about investing in copper in your country as you were before the meeting?
Ntheye Lungu | Guest Writer