22 Oct Part 1 – Resource development and infrastructure constraints in Africa and other emerging markets: A tale of two sectors
In the first part of this series on infrastructure development in Africa, Conrad Marais looks at the historic structural shortcomings of the relationship between resource and infrastructure investment and development and how these are being addressed to open up new opportunities for investors and mining companies (including juniors) to access infrastructure.
As Africa and other emerging markets position themselves to exploit their vast mineral and petroleum resources – in the case of Africa, it is believed to hold 30% of the world’s mineral reserves and 10% of its reserves of oil – the issue of the lack of infrastructure continues to frustrate governments, investors and developers.
Although the construction of roads, railways, ports, airports and power infrastructure in emerging markets has increased over the last decade, the contemporaneous explosion of interest in mining and petroleum in these markets has exacerbated the shortfall.
Under-investment and mis-management is partly responsible for this, as is the inherently difficult nature of developing infrastructure such as railways or hydro power which have high capital costs and are invariably highly politicised.
The problem has been ameliorated by the proliferation of comprehensive host government agreements entered into between governments and sovereign investors or multi-nationals, imposing significant obligations on those developers to construct infrastructure. However, the financial necessity for the developers of these projects to secure priority access means that it has been difficult for small mining companies and other industries to gain access to that infrastructure. The burden for a bulk commodity producer, for example, to share rail lines with agricultural users or small producers is likely to outweigh the necessary financial investment required and therefore single-use and single-purpose infrastructure becomes an eventual prerequisite in negotiations with government.
As a result, the vast majority of resource developers – juniors and mid-tier companies included – and other industries, have found it increasingly difficult to access infrastructure required in order to make their projects commercially viable. It’s a common story amongst developers and a difficult message to sell to investors; great project but there’s no power, no rail and no port.
To compound matters for resource developers in particular, it has historically – for a number of reasons – been very difficult to get the attention of the traditional financiers of infrastructure in Africa, development finance institutions (DFIs) such as African Development Bank, Industrial Development Corporation, IFC, Development Bank of Southern Africa, Proparco of France, DEG of Germany, FMO of Holland and the European Investment Bank.
Although there are many positive examples of DFI involvement with Australian resource companies operating in Africa – Equinox’s Lumwana project in Zambia being one of them – DFIs have often cited environmental concerns and management issues associated with resource projects. The availability of private investment for these projects has also tended to exclude DFI involvement.
Equally, the Australian resource sector’s understanding of infrastructure development in emerging markets is not extensive, particularly in relation to the financing structures required and the risks involved in DFI funding. Many junior explorers in Australia also have a negative view of these institutions, noting uncontrollable due diligence exercises, lengthy credit approval processes and burdensome environmental conditions.
There are also few forums, certainly with respect to Africa, where the parties can meet on a meaningful basis by incorporating the resource and infrastructure sectors. None of the larger African mining conferences, including Indaba in Cape Town and Africa Down Under in Perth, actively incorporate infrastructure as part of the programme. The same can be said about infrastructure conferences such as the Africa Energy Forum (in Europe) which are not generally attended by mining companies. There are very few (if any) forums where resource and infrastructure players can confer on integrated solutions.
As a result, the resource and infrastructure sectors have tended to operate independently with the consequence that each sector struggles to understand the drivers, players and risks of the other. More fundamentally, there has been very little cross pollination of projects or integration of long term goals between resource and infrastructure developers. For two sectors that so heavily depend on each other for progress, this has not been helpful for Africa’s development needs.
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So, where does that leave the vast majority of resource developers and other industries struggling to get their product to market?
As mentioned, the answer some years ago may not have been good news but with the increased activity in mining and petroleum exploration throughout Africa, there are signs that infrastructure developers and investors (particularly DFIs) are increasing their focus on resources projects as a way to progress infrastructure in Africa. The attention of DFIs has moved to resources projects as a means of progressing (and importantly, funding) infrastructure development.
To the DFIs the developmental benefits are clear. Resource projects, particularly those involving bulk commodities can transform local economies (because of the sheer size of the projects) and can open up mining and other industry enclaves (such as agriculture) through infrastructure development.
In addition to the direct developmental benefits that a resources project can deliver (for example, employment and accommodation), from a financing perspective these projects can mitigate many risks that have troubled infrastructure projects in emerging markets. These risks include, for instance, revenue concerns/offtake. An integrated power project which has as its key offtaker a robust mining project goes a long way to alleviating DFI (and commercial lender) concerns regarding the creditworthiness of state utilities.
The increased interest in resource development has been aided to a large extent by the proliferation of Australian companies now operating in Africa – some say over 250 Australian companies are currently working on some 650 projects – bringing with them Australia’s high standards of environmental and corporate social responsibility; something particularly dear to DFI hearts.
It also has not gone unnoticed that apart from the obvious environmental discipline and corporate social responsibility that is being built into mining projects, the down-to-earth approach of Australians has had a significant impact on the way in which mining is viewed in Africa. The more inclusive approach has arguably had a marked impact on the way the industry is viewed by investors and, most importantly, Africans.
The increased interest by DFIs opens up opportunities for resource companies, especially smaller developers, to facilitate, encourage and even participate as third party developers of infrastructure, relying on their resource projects to form the backbone of infrastructure development, using DFI (and possibly commercial lender) limited-recourse debt.
The DFI message remains clear; there will always be an interest in well-structured projects with developmental benefits and in the case of resources and infrastructure projects, the synergies for DFIs are potentially significant.
Of course, the task for resource developers to put together a supporting infrastructure project should not be underestimated. Questions arise as to how to get involved, whether as investor, offtaker or simply a promoter in the infrastructure development. Again, the fact that there is little leadership or cohesion between resource and infrastructure development makes it difficult for smaller players to envisage how to put together significant infrastructure around their relatively small projects.
There are also significant issues inherent in sharing infrastructure such as rail and ports which have confounded governments and sponsors. In his article “Building an African Infrastructure“, Professor Paul Collier notes a number of these issues in the context of rail infrastructure including the weighty subjects of operations and maintenance, regulation, access and pricing. Another obvious issue is the trans-jurisdictional and political nature of rail networks ultimately requiring co-operation and agreement between states on those issues of access and pricing. For investors who have barely managed to get comfortable with the sovereign risk in one country, taking further risk over two or three additional countries may be a step too far.
But, Professor Collier concludes that these issues are not insurmountable and can be solved, for example, by putting in place contracts that are subject to dispute settlement boards and relying on price discrimination between, say, resource and agricultural users to address concerns about having to subsidise high fixed costs. The solutions exist.
As already noted, the role of DFIs in leading the charge to put forward those solutions is critical but it’s a two-way street. The challenge is there for resource companies to also show leadership by engaging with infrastructure developers and those financing these projects such as development finance institutions to better understand who they are, how they operate and what they need. Although there is little doubt that solutions are potentially complicated (politically and structurally) and will take time to put in place, the boom in the resources sector has given rise to a unique opportunity for the sectors to better co-operate to fully unleash the potential of Africa and other emerging markets.
In Part 2, we’ll look at structuring projects for DFIs including a review of key bankability issues which concern these critical players in emerging market development .
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