Killing the golden goose. Barrick Gold suspends Lumwana

Barrick Gold has announced that it is to put its $1 billion Lumwana copper mine in Zambia on care and maintenance following the Zambian government’s plans to up open pit mining royalties from 6% to 20%

By: Lawrence Williams

News that Barrick Gold is to put its Lumwana copper mine in Zambia on care and maintenance due to a huge increase in royalty payments should send warning signals to governments of resource rich nations everywhere.  In this case, as in any other where over onerous taxation or royalty impositions can have an impact, the government will be the loser in loss of export revenues, and perhaps most of all in the loss of tax revenues from mine employees and the knock-on effect on employee families and local suppliers to the mine itself and others who depend on mineworkers for their livelihoods.  A major mine like Lumwana tends to support perhaps ten times the number of people actually employed on the mine itself, and the operation itself directly employs around 4,000 people!

In countries where the government supplies financial support to the unemployed, the adverse effects on government finances would be even greater.

Where the warning should strike home is that many in government will believe that a major mining company like Barrick will have invested so much in the mining operation that it could not possibly walk away.  But in today’s environment, low metals prices – particularly in the copper and gold sectors, coupled with aggressive institutional shareholder pressures will force companies to exit operations which may be making significant losses.

Indeed in Barrick’s case also one only has to look at the massive Pascua Lama gold/copper project straddling the Chilean and Argentinian borders to recognise companies are being pressured not to throw good money after bad.  Barrick has spent billions of dollars already on Pascua Lama and while it has not yet intimated it is abandoning the project altogether, there are many out there who doubt that the proposed mine, with its considerable environmental problems, will ever come into production without a very big increase in the prices of both gold and copper and further billions of dollars in capital costs.  In financial terms Lumwana is small beer in comparison.

While anti-mining activists might argue the point, there is little doubt that a significant sized long-life mining project can bring huge benefits to local communities in otherwise poor countries, often in remote area effectively off the government grid.  Mining companies nowadays are not just about digging out the dirt without caring about the environment but have developed massive social consciences (or have had them forced upon them) and provide power, clean water, schooling, medical facilities, huge infrastructure benefits and many other positive attributes to the communities around them at zero cost to the government.  There are also enormous pressures on the mining companies to develop sustainable businesses around the operation so the local population has something to fall back on when the mine runs out of ore, perhaps many years hence.

All these benefits may be nipped in the bud by shortsighted government involvement which can, not only lead to mine closures or suspension, but also discourage other companies from exploring, and hopefully ultimately developing, other new mining operations as well as prevent existing project expansions:  In Zambia Glencore and First Quantum have both put already major mine expansion projects on hold.

What the Zambian government is proposing is to raise royalties on open pit mines from 6% to 20% and drop corporation tax on these operations from January 1st.  It sees this as an easier, and fairer, way of collecting revenues from the miners, but takes no account of falling metal prices.  Barrick’s Lumwana is currently producing copper at a small loss (it is a high cost mine) so an increase in royalties of this nature would be crippling.  Zambian politicians have felt that mining companies have been managing to avoid taxes by inflating apparent costs and that a royalty-only regime would prevent this from happening.  Underground mines in Zambia are not going to be quite so badly hit with royalties being raised from 6% to 8%.

Overall the government reasoning is that the move from tax to increased royalties will enable a more “equitable distribution of the mineral wealth between government and the mining companies.” according to Zambia’s Finance Minister.

Mining companies are worried that there is an increasing move among African nations in particular to alter their resource tax regimes to generate more revenues from the industry.  There seems to be a lack of realisation that mining development costs and risks are high and if government revenue raising structures are too onerous, not only will mining companies be wary about major investments, but the bankers won’t make capital available if they also see the risks of non-repayment of loans as possible.

In Zambia’s case there is thus huge pressure on the government from the country’s key mining sector to pull back from its proposals.  The Barrick decision may bring home the fact that the industry is not bluffing in its opposition to the new revenue raising regime as putting new mining projects and expansions, and some existing operations, in jeopardy while prices remain low.  Even if there is a change of heart, though, it may be too late for Lumwana, which produces over 80,000 tonnes of copper a year.  Barrick has a policy of closing down, or selling off mining operations which no longer meet its financial criteria and Lumwana is one of these regardless of the tax regime.

Barrick co-President, Kevin Dushinsky, noted in an announcement on the suspension  “The introduction of this royalty has left us with no choice but to initiate the process of suspending operations at Lumwana. Despite the progress we have made to reduce costs and improve efficiency at the mine, the economics of an operation such as Lumwana cannot support a 20 percent gross royalty, particularly in the current copper price environment”

Barrick is expected to write down the $1 billion carried value of the company in its books, probably in total and although in a statement the company’s other co-President, Jim Gowans commented “We sincerely regret the impact this will have on our people, as well as the communities and the businesses that depend on Lumwana, and we remain hopeful that the government will consider an alternative solution that will allow the mine to continue operating”.  But as we noted above, without a significant copper price increase Lumwana’s days are probably numbered regardless, at least under Barrick control.

Barrick says it will initiate procedures to transition Lumwana to care and maintenance with major workforce reductions planned to commence in March, following the legally required notice period. The transition to care and maintenance is expected to be completed in the second quarter of 2015.

 

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2 thoughts on “Killing the golden goose. Barrick Gold suspends Lumwana

  1. Doug Beattie January 4, 2015 / 2:44 am

    I think there needs to be some middle ground found in this battle since there are some clear examples of tax avoidance going on. One company is lending to its southern African subsidiary at what I would call usurious interest rates which has the net effect of transferring cash flow to a low tax jurisdiction which I think you could name.

    And this is not just a southern African phenomenon but there is an interesting case going on in Canada with Cameco who claim they sell much of their uranium in the high teens $ to their Swiss subsidiary who then sells it to the final customers for at least double the price on average. The net effect is to establish tax losses in Canada while paying minimal tax in Switzerland. In effect, some would claim Canadian tax payers are subsidizing Cameco. This part of the story is well known and is in the courts to resolve.

    The part that is not well known is that the provincial government of Saskatchewan was not happy with this set up and knew it would take years to resolve. So instead they brought in an onerous tiered royalty structure not to dissimilar to what Zambia is up to in order to counter the corporate financial engineers. The moral of the story is some accountants and their high priced advisers need to be taken out for a good flogging at times.

    Like

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